Reference no: EM132691109
Consider an 7% coupon bond with 2 years time-to-maturity and $1000 face value, is selling for $980 and making annual coupon payments. The constant market reinvesting rates in the next 2 years is 8%. Based on the above information to answer part (a).
(a) Compute the total future value of your investment and realized yield if we consider reinvestment of bond's coupon payment.
Now, based on the below information to answer (b) and (c). The term structure for zero coupon bonds is given as following:
Maturity (Years): 1 2 3
YTM: 7% 6% 8%
Consider that government is planning to issue a 3-year maturity coupon bond, paying annual coupon payments with a coupon rate of 10%. Its face value is $1000.
(b) Assume there is no arbitrage in the market. What should the bond price be without violating the no-arbitrage condition?
(c) Under the liquidity preference theory, suppose the liquidity premium is 2%. The bondholder plans to sell the bond at the beginning of the third year, what would be the expected selling price? Hint: what is the value of E(r3)?
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