Prices of zero-coupon bonds reveal the following pattern of forward rates: 0f1 =

Question

Prices of zero-coupon bonds reveal the following pattern of forward rates: 0f1 = y1 = 5%, 1f1 = 7%, 2f1 = 8%. In addition to the zero coupon bonds, investors also may purchase a 3-year bond making annual coupon payments of $60 with par value of $1,000.

(a) What is the price of the coupon bond and its YTM?

(b) Under the expectations hypothesis, what is the expected realized compound yield of the coupon bond?

(c) What is y3? Compare to the expected realized compound yield.

(d) If you forecast that the term structure in one year will be flat at 7%, what is your forecast for the expected rate of return on the coupon bond for the one-year holding period?

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