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Term+Structure

# Term+Structure - FINA 3104 Practice Problems Fall 2011 The...

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FINA 3104 Practice Problems Fall 2011 The Term Structure of Interest Rates 1. True or False (a) According to the expectations hypothesis, a rising yield curve implies that interest rates are expected to increase in the future. (b) The term structure of interest rates is the relationship between the coupon rate on a bond and time to maturity of the bond. (c) The liquidity preference theory of the term structure of interest rates states that forward rates do not equal expected future interest rates. 2. Short Rates and Yield Curve You are given the following prices for three zero-coupon bonds in Year 0: Bond A (1-year zero-coupon bond): \$900 Bond B (2-year zero-coupon bond): \$800 Bond C (3-year zero-coupon bond): \$700 Assume that all short rates are known in Year 0 with certainty. (a) What is the short rate in Year 0? What is the price of Bond B in Year 1? (b) What is the short rate in Year 1? What is the price of Bond C in Year 2? What is the short rate in Year 2? (c) Calculate and plot the yield curve in Year 0. 3. Forward Rates and Yield Curve We are currently in Year 0 and observe the following 1-year forward rates.

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