Question

Current 1-year spot rate is 3.5%. Annual volatility of interest rates is 10%. If rᵣ₁ʟ =4.5%, calculate the price of a 2-year bond with annual 3% coupon (paid annually). Assume face value of $100.

Answer 1

To calculate the price of a 2-year bond with a 3% coupon paid annually, we need to discount the future cash flows using the appropriate discount rate. The price of the bond can be determined by adding the present value of each cash flow.

Step-by-step explanation:

To calculate the price of a 2-year bond with a 3% coupon paid annually, we need to discount the future cash flows using the appropriate discount rate. The price of the bond can be determined by adding the present value of each cash flow. We can use the formula:

Price = Coupon Payment / (1 + r)^1 + Coupon Payment / (1 + r)^2 + ... + (Coupon Payment + Face Value) / (1 + r)^n

where r is the discount rate, Coupon Payment is the annual coupon payment, and n is the number of years until maturity. In this case, let's assume the discount rate is 3.5%, the annual coupon payment is $3, and the face value is $100. Using the formula, we can calculate the price of the bond.