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ARE 171A
Finance Homework 3
Winter 2011
A. Havenner
Seven questions on three pages. Please show your setup equations explicitly, and box your answers.
Price bonds per $1,000 of face value, assuming coupons pay semiannually unless otherwise stated
(as in question 1). Stock dividends are quarterly unless otherwise stated.
[10]
1. Suppose the one year AA corporate bond rate is 5.875% and the two year rate is 6.25%.
A $1,000 face value classroom bond pays coupons
annually
of $50 and matures exactly two years
from today; what is its value? (Show your setup explicitly so that we can see how you solved this
problem.)
2. Treasury Strips
(np)
are Treasury obligations that have had the coupons stripped off,
i. e.,
they are pure discount bonds.
1
The January 19,2011
Wall Street Journal
reported the following
annualized spot yields to maturity for U.S. Treasury
np
Strips:
Years to Maturity
% Yield
Notation
1
0.27
r
l
2
0.60
r
z
3
1.01
r
3
Be sure to use the class notation
(e.g.,
r
1
and f
l
)
and show your setup including timing diagrams in
answering the questions below. Notice that yields are in annual percent, so
e.g.,
the yield of .27%
implies an annual interest rate of .0027.
[8]
i)
What is the implied forward rate from year 1 to year 2 according to the Expectations
Hypothesis?
ii)
What is the implied forward rate from year 2 to year 3 according to the Expectations
Hypothesis?
[3]
iii)
Is this a normal yield curve or an inverted yield curve, and very briefly, why?
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This note was uploaded on 02/27/2012 for the course ARE 171A taught by Professor Whitney during the Spring '08 term at UC Davis.
 Spring '08
 WHITNEY

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