Bonds - Yields and Interest Rates_Week 7

Relationship between discount factor and spot rates

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Unformatted text preview: ween discount factor and spot rates: Relationship between discount factor and forward rates: 1 Econ136: Financial Economics; Spring 2013 BONDS: Discount Factors, Interest Rates, and Arbitrage Interest Rates and Yields 1. Consider 2 bonds: 2-year zero-coupon bond with yield 7% 1-year zero-coupon bond with yield 4% o Why might these yields be different? In the real world, all bonds should offer identical returns. o In this situation, we see that short-term interest rates will increase in a year (an upward-sloping yield curve) With these bonds, we construct the following 2-year bond strategies: Buy 2-year bond (7% yield) and hold until maturity Price = FV/(1+Y)2 = $1000/(1.07)2 = $873.44 Invest $873...
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This note was uploaded on 05/03/2013 for the course ECON 136 taught by Professor Szeidl during the Spring '08 term at University of California, Berkeley.

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