410 HW #21
1.
As of end of year 2010:
%
3
%,
3
%,
3
1
1
2
1
=
=
=
+
e
t
t
t
YTM
YTM
YTM
Face value of all bonds: 1000
All bonds for this problem pay zero coupon.
Strategy 1: Buy 1 year bond, roll over to another 1 year bond.
Strategy 2: Buy 2 year bond (matures at end of 2012)
a.
What is the current price of the 1year bond? What is the current price of the two
year bond?
b.
Suppose at the end of 2011 you need to liquidate and get out of either strategy.
Suppose your prior expectation of future spot rates was correct, so that as of the
end of 2011
%.
3
1
=
t
YTM
Calculate the returns from liquidating strategy 1 and
strategy 2.
c.
Suppose at the end of 2011 you need to liquidate and get out of either strategy.
Suppose your prior expectation of future spot rates was
incorrect
, so that as of the
end of 2011
%.
5
1
=
t
YTM
Calculate the returns from liquidating strategy 1 and
strategy 2.
d.
In light of your answers above, explain why investors would probably not be
willing to buy the two year bond at the end of 2010 if its YTM is only 3%.
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 Fall '10
 BrianBoyer
 Liquidity, YTM

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