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

Question

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

Maturity (years)         YTM

1                              10.7 %

2                              11.7

3                               12.7

a. What are the implied one-year forward rates? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Maturity (years)      YTM       Forward Rate

1                          10.7 %      ______

2                          11.7 %      _______

3                           12.7 %    _______

c-1. If you purchase a two-year zero-coupon bond now, what is the expected total rate of return over the next year? (Hint: Compute the current and expected future prices.) Ignore taxes. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Expected total rate of return

c-2. If you purchase a three-year zero-coupon bond now, what is the expected total rate of return over the next year? (Hint: Compute the current and expected future prices.) Ignore taxes. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Expected total rate of return

Explanation / Answer

a. What are the implied one-year forward rates?.

c-1 The 2 year zero will be a 1 year zero next year and will therefore sell at $887.23($1000/1.1271)

2 year bond Expected total rate of return= ($887.23/$801.43 )-1 = 10.71%

c-2 Similliarly the current 3 year zero wiil be 2 year zero and will therefore sell at $773.32 ($1000/(1.1271*1.1473))

3year bond Expected total rate of return =($773.32/$698.6) -1 = 10.71%

Maturity (years)        YTM Price $ Forward Rates 1 10.70% 903.34 NA( short rate10.7%) 2 11.70% 801.48 12.71 % = (1.1170)^2/1.10.7 -1 3 12.70% 698.60 14.73% = ((1.127)^3/(1.117)^2) -1

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