You observe the following term structure: If you believe that the term structure

Question

You observe the following term structure:

If you believe that the term structure next year will be the same as today’s, what will be the return on 1-year and 4-year zero-coupon bonds? (Do not round intermediate calculations. Round your answers to 1 decimal place.)

    

   

Will the 1-year or the 4-year zeros provide a greater expected 1-year return?

Effective Annual YTM   1-year zero-coupon bond 4.3%   2-year zero-coupon bond 4.4      3-year zero-coupon bond 4.5      4-year zero-coupon bond 4.6   

Explanation / Answer

The return on one year bond is = 4.3%

The price of 4 year bond today = 1,000/ (1.046)4

Price of 4 year bond today = 835.36

If yield curves is unchanged, the bond will have 3-year maturity and price will be = 1,000/ (1.045)3

If yield curves is unchanged, the bond will have 3-year maturity and price will be = 876.30

Return = (876.30 - 835.36)/ 835.36

Return = 4.90%

The longer term bond has given the higher return in this case at it's YTM fell during the holding period

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.