Question

Consider the following $1,000 par value zero-coupon bonds: A- yrs to maturity: 1, YTM 5.7% B- yrs: 2, YTM 7.2% C- yrs: 3, YTM 7.7% D- yrs: 4, YTM 8.2% E- yrs: 5, YTM 10.5% The expected 1-year interest rate 2 years from now should be _________

Answer 1

When interest rates rise, the price of a bond decreases and the bond becomes an unattractive investment. In this scenario, the bond's price would not exceed $964 because an investor could invest $964 and receive the same amount as the bond's expected payments.

Step-by-step explanation:

When interest rates rise, the price of a bond decreases. In this case, the bond's interest rate is less than the market interest rate, so the bond would be an unattractive investment. To entice investors to buy the bond, the seller would lower its price below the face value of $1,000. The expected payments from the bond one year from now are $1,080, but since interest rates are 12%, an investor could invest $964 and receive the same amount. Therefore, the bond's price would not exceed $964.