The current yield curve for default-free zero-coupon bonds is as follows: What a

Question

The current yield curve for default-free zero-coupon bonds is as follows: What are the implied 1-year forward rates? (Do not round intermediate calculations. Round your answers to 2 decimal places. Omit the "$" & "%" signs in your response.) Assume that the pure expectations hypothesis of the term structure is correct. If market expectations are accurate, what will be the pure yield curve (that is, the yields to maturity on 1- and 2-year zero coupon bonds) next year? Shift upward Shift downward If you purchase a 2-year zero-coupon bond now, what is the expected total rate of return over the next year? What if you purchase a 3-year zero-coupon bond? Ignore taxes. (Do not round intermediate calculations. Round your answers to 2 decimal places. Omit the "$" & "%" signs in your response.) What should be the current price of a 3-year maturity bond with a 8% coupon rate paid annually? If you purchased it at that price, what would your total expected rate of return be over the next year (coupon plus price change)? Ignore taxes. (Do not round intermediate calculations. Round your answers to 2 decimal places. Omit the "$" & "%" signs in your response.)

Explanation / Answer

Forward Rates Year 2 => [(1 + 6.5%)2 / ( 1+ 5.5) ] -1

Forward Rates Year 2 => 7.5%

Forward Rates Year 3 => [ ( 1+8.5% )3 /(1+6.5%)2 ] -1

Forward Rates Year 3 => 12.6

Answer b

It will shift downward.

Answer c

Let face avlue be 1000

Bond price in year 2 => 1000 / ( 1.065)2 => 881.66

Bond price in year 3 => 1000 / (1.085)3 => 782.91

rate of return fro yera2 => (1000 / 881.66)1/2 -1 => 6.50%

Rate of return for year 3 => ( 1000 / 782.91)1/3 -1 => 8.50%

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