Ask Question
BusinessBusiness
2 February, 01:22

The yield to maturity on 1-year zero-coupon bonds is currently 7.5%; the YTM on 2-year zeros is 8.5%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon rate of 10%. The face value of the bond is $100.

a. At what price will the bond sell?

b. What will the yield to maturity on the bond be?

c. If the expectations theory of the yield curve is correct, what is the market expectation of the price that the bond will sell for next year?

d. Recalculate your answer to (c) if you believe in the liquidity preference theory and you believe that the liquidity premium is 1.5%.

+1
Answers (1)
  1. 2 February, 01:36
    0
    Task a: $102.74

    Task b: 2.73%

    Task c: $100.44

    Task d: $101.84

    Explanation:

    a. At what price will the bond sell?

    Solution:

    The price of the bond = Coupon payment for year 1 / (1 + YTM on 1-year zero-coupon bonds) + (Coupon payment for year 2 + maturity Value) / (1 + YTM on 2-year zero-coupon bonds) ^2

    = $10 / (1+7.5%) + ($10 + $100) / (1+8.5%) ^2

    =$9.30 + $93.44

    =$102.74

    b. What will the yield to maturity on the bond be?

    Solution:

    We have following formula for calculation of bond's yield to maturity (YTM)

    Bond price P0 = C / (1+YTM) + (M+C) / (1+YTM) ^2

    Where,

    P0 = the current market price of bond = $102.74

    C = coupon payment = 10% of $100 = $10

    YTM = interest rate, or yield to maturity = ?

    M = value at maturity, or par value = $ 100

    Now we have,

    $102.74 = $10 / (1+YTM) + $110 / (1+YTM) ^2

    YTM = 2.73%

    (c) If the expectations theory of the yield curve is correct, what is the market expectation of the price that the bond will sell for next year?

    Solution

    Under expectation theory

    ft = E (rt)

    Therefore (1 + ft) = (1.085) ^ 2 / 1.075 = 1.0951

    Or ft = E (rt) = 1.0951 - 1 = 0.0951 or 9.51%

    By using this theory the bond price on year,

    P = $110/1.0951 = $100.44

    (d) Recalculate your answer to (c) if you believe in the liquidity preference theory and you believe that the liquidity premium is 1.5%.

    Solution

    If the liquidity premium is 1.5%,

    Then ft = E (rt) + L

    Where L is liquidity premium = 1.5%

    Therefore,

    E (rt) = ft - L = 9.51% - 1.5% = 8.01%

    And price of the bond

    P = $110/1.0801 = $101.84
Know the Answer?
Not Sure About the Answer?
Find an answer to your question 👍 “The yield to maturity on 1-year zero-coupon bonds is currently 7.5%; the YTM on 2-year zeros is 8.5%. The Treasury plans to issue a 2-year ...” in 📗 Business if the answers seem to be not correct or there’s no answer. Try a smart search to find answers to similar questions.
Search for Other Answers
You Might be Interested in
Blain Company has $10,000 of accounts receivable that are current, $5,000 that are between 0 and 30 days past due, $3,000 that are between 30 and 60 days past due, and $800 that are more than 60 days past due.
Answers (1)
Assume that the economy is at equilibrium at $10 trillion, with a marginal propensity to consume of 0.75. If exports rise by $0.5 trillion and imports increase by $0.7 trillion, equilibrium income will: a. fall by $0.2 trillion. b. not change. c.
Answers (1)
Before it was publicly known that IBM was going to take over Lotus Development, an IBM secretary told her husband, who told two co-workers, who told friends, relatives, business associates, and even a pizza delivery man.
Answers (1)
Which type of brand tends to have the lowest price? private brand national brand name brand generic brand
Answers (1)
Frohe Inc. sponsors a restricted stock units award plan under which employees can choose to receive either company stock or cash. During the vesting period, the company should recognize the award as a credit to a:
Answers (1)
New Questions in Business
What are the order of in which management can take legal action against a employee
Answers (1)
What best describes an entrepreneur? a. Someone who initiates and assumes the financial risk of a new business enterprise. b. A person who knows how to evaluate which stocks to purchase. c. Someone who can expertly manage other people's investments.
Answers (1)
JRN Enterprises just announced that it plans to cut its dividend from $3.50 to $2.50 per share and use the extra funds to expand its operations.
Answers (1)
Sykora, Inc., which uses a predetermined overhead rate based on direct labor hours, estimated total overhead for the year to be $12,000,000 and total direct labor hours to be 320,000 hours. Calculate Sykora's predetermined overhead rate.
Answers (1)
Appalachian mountain goods has paid increasing dividends of $.10, $.12, $.15, and $.20 a share over the past four years, respectively.
Answers (1)
Home » Business » The yield to maturity on 1-year zero-coupon bonds is currently 7.5%; the YTM on 2-year zeros is 8.5%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon rate of 10%.
Sign Up Forgot Password?