 Business
14 April, 23:35

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1. 15 April, 00:35
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a. At what price will the bond sell?

\$102.71

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

0.0952 or 9.52%

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?

\$101.37

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

\$102.78

Explanation:

current YTM for zero coupon bonds = 8.5% for 1 year bonds and 9.5% on 2 year bonds

The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon rate of 11%. The face value of the bond is \$100.

bond price = PV of maturity value + PV coupons

\$100 / (1 + 9.5%) ² = \$83.40 [\$11 / (1 + 8.5%) ] + [\$11 / (1 + 9.5%) ²] = \$10.14 + \$9.17 = \$19.31 issue price = \$83.40 + \$19.40 = \$102.71

YTM = [C + (FV - PV) / n] / [ (FV + PV) / 2] = [11 + (100 - 102.71) / 2] / [ (100 + 102.71) / 2] = 0.0952 or 9.52%

next year's price:

\$100 / (1 + 9.5%) = \$91.32 \$11 / (1 + 9.5%) = \$10.05 total = 101.37

next year's price if you believe in liquidity preference theory (1.5%):

\$100 / (1 + 9.5% - 1.5%) = \$92.59 \$11 / (1 + 9.5% - 1.5%) = \$10.19 total = \$102.78