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Currently the term structure is as follows: One-year spot rate      2% Two-year spot rate       3% Three-year...

Currently the term structure is as follows:

One-year spot rate      2%

Two-year spot rate       3%

Three-year spot rate      4%

You have a one-year investment horizon one-, two-, and three-year zero coupon bonds are available.

a. Which bonds should you buy if you strongly believe that at year-end the term structure remains

unchanged (i.e., one, two, and three year spot rates remain the same)?

b. Redo part (a) assuming at year-end the term structure shifts as follows:

One-year spot rate      6%

Two-year spot rate      7%

Three-year spot rate    8%

c. What conclusion(s) can you make by comparing the results of parts (a) and (b) above?

Solutions

Expert Solution

  

a. Which bonds should you buy if you strongly believe that at year-end the term structure remains

I'm sure you should buy this bond

Two-year spot rate 3% then sell in one year.

Spot rate is the price quoted for the immediate settlement of a product, security or currency. Spot rate, also referred to as "spot price", is the current market value of an asset at the moment of the quote.

b. Redo part (a) assuming at year-end the term structure shifts as follows:

One-year spot rate 6%

Two-year spot rate 7%

Three-year spot rate 8%

Year

Spot Rate

1

6.7%

2

7.6%

3

7.8%

c. What conclusion(s) can you make by comparing the results of parts (a) and (b) above?

Spot rate is the contract price for a transaction, which takes place immediately (which is the price at that location). A forward rate, on the other hand, is the settlement price of a transaction that does not take place until a predetermined date in the future; It's a forward price.

ekkarill92 answered 2 years ago
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