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College of Business - Department of Finance - Finance 300 (Financial Markets) Professor James Jackson Boot Strapping the Yield Curve Question: Should you buy a term note based on the offered YTM of the yield curve, or risk combining various shorter- term maturity notes and one-year securities? What minimum one-year rate do you have to earn in various years to win this game? Example #1 Maturity (Yrs.) Face (\$) (YTM) [Face (\$)] * [(1+ YTM /n) t*n ]1 Year Rate (t-1)Interest Earned (\$) Yield (%) 0 \$1,000.00 \$1,000.00 1 \$1,000.00 0.0300 \$1,030.00 0.03000 \$30.00 0.03000 2 \$1,000.00 0.0400 \$1,081.60 0.05010 \$51.60 0.05010 3 \$1,000.00 0.0460 \$1,144.45 0.05810 \$62.85 0.05810 4 \$1,000.00 0.0500 \$1,215.51 0.06209 \$71.06 0.06209 5 \$1,000.00 0.0520 \$1,288.48 0.06004 \$72.98 0.06004 Three-Year Note (Compound Return) = (1.046)* (1.046)* (1.046) = 1.144 –1 = .144 1 Year Rate (t-1) equals: [(1+.046) 3 ]/[(1+.04) 2 ] = 1.0581 – 1 = .0581 1.0581 ) = 1.144 –1 = .144 Answer: If you can earn more than 5.81% on a one-year note starting at the beginning of year three you will win the game! Yield Curve

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