1 answer

The current yield curve for default-free zero-coupon bonds is as follows: Maturity (Years) 10 YTM (%)...

Question:

The current yield curve for default-free zero-coupon bonds is as follows: Maturity (Years) 10 YTM (%) 10.5% 11.5 12.5 points

The current yield curve for default-free zero-coupon bonds is as follows: Maturity (Years) 10 YTM (%) 10.5% 11.5 12.5 points a. What are the implied 1-year forward rates? (Do not round intermediate calculations. Round your answers to 2 decimal places.) eBook Forward Rate Maturity 2 years 3 years Print References b. Assume that the pure expectations hypothesis of the term structure is correct. If market expectations are accurate, what will be the yield to maturity on 1-year zero-coupon bonds next year? Shift downward Shift upward c. Assume that the pure expectations hypothesis of the term structure is correct. If market expectations are accurate, what will be the yield to maturity on 2-year zero-coupon bonds next year? Shift upward Shift downward d. If you purchase a 2-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 1 decimal place.) Expected total rate of return (2-year bond)

Answers

a) Using expectation theory,

(1 + s2)^2 = (1 + s1) x (1 + 1f1)

where, s2 - 2 year rate = 11.50%, s1 - 1 year rate = 10.50%,

=> 1f1 = (1 + 11.50%)^2 / (1 + 10.50%) -1 = 12.51%... 2nd year rate

Similarly,

(1 + s3)^3 = (1 + s2)^2 x (1 + 2f1)

=> 2f1 = (1 + 12.50%)^3 / (1 + 11.50%)^2 - 1 = 14.53%

b) Shift upward as the 2nd year rate is higher than current 1 year rate.

c) Shift upward.

d) Rate next year = s1 = 10.50%

.

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