Question

4) The current annualized yield on a 2-year STRIPS is 0.13% and the annualized yield on a 3-year STRIPS is 0.15% (WSJ for week ended 7/31/2020). According to the expectations theory of interest rates, what will be the annualized yield on a 1-year STRIPS two years from now? What would you expect to pay for this STRIPS with a $1,000 face value two year from now?

note: no excel or calculator. using formula only

5. Suppose you have a 3.25% coupon bond with a ytmof 1.50 percent and a term-to-maturity of 3 years. The bond pays its coupon ANNUALLY(once per year) and has a face value of $1,000. What is this bond’s price? What is its duration?

Answer 1

4. According to the expectations theory of interest rates, what will be the annualized yield on a 1-year STRIPS two years from now?

(1 + 3 years Interest Rate)^3 = (1 + 2 years Interest Rate)^2 * (1 + 1 year forward after 2 years)

1.0015^3 = 1.0013^2 * (1 + 1 year forward after 2 years)

1.00451 = 1.0026 * (1 + 1 year forward after 2 years)

1 year forward after 2 years = 0.19%

What would you expect to pay for this STRIPS with a $1,000 face value two year from now?

Value of Strip = Face Value / (1 + 1 year forward after 2 years)

Value of Strip = 1000 / 1.0019

Value of Strip = $998.10

5. Bonds Price and Bonds Duration

Bonds Price = $1050.96

Bonds Duration = 2.91 Years