Question

The current yield curve for default-free zero-coupon bonds is as follows:

Maturity (Years)	YTM (%)
1	10	%
2	11
3	12

a. What are the implied 1-year forward rates? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

2 years	%
3 years	%

b. Assume that the pure expectations hypothesis of the term structure is correct. If market expectations are accurate, what will be the yield to maturity on 1-year zero-coupon bonds next year?

• Shift upward.

• Shift downward.

c. Assume that the pure expectations hypothesis of the term structure is correct. If market expectations are accurate, what will be the yield to maturity on 2-year zero-coupon bonds next year?

• Shift downward.

• Shift upward.

d. If you purchase a 2-year zero-coupon bond now, what is the expected total rate of return over the next year? (Hint: Compute the current and expected future prices.) Ignore taxes. (Do not round intermediate calculations. Round your answer to the nearest whole percent.)

Expected total rate of return 2-year bond

%

e. What is the expected total rate of return over the next year on a 3-year zero-coupon bond? (Do not round intermediate calculations. Round your answer to the nearest whole percent.)

Expected total rate of return 3-year bond

%

f. What should be the current price of a 3-year maturity bond with a 12% coupon rate paid annually? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Current price

g. If you purchased the coupon bond at the price you computed in part (f), what would your total expected rate of return be over the next year (coupon plus price change)? Ignore taxes. (Do not round intermediate calculations. Round your answer to the nearest whole percent.)

total expected rate of return

%

Answer 1