Answer:
Check the explanation
Step-by-step explanation:
As is observable in the first attached image below, the yield curve is upward sloping. According to the pure expectations hypothesis which states that current short-term interest rates are a reflection of long-term term interest rates, market participants should expect long-term interest rates to rise going forward.
(b) Implied one-year forward rate calculation:
![1+f2 = [(1+y2)^(2)] / (1+y1)](https://img.qammunity.org/2021/formulas/business/college/2w23lb23c7z26yb4a8jm0dbv20b1s09c9f.png)
f2 = 1.0006%
![f3 = [{(1+y3)^(3)} / {(1+y2)^(2)}] - 1](https://img.qammunity.org/2021/formulas/business/college/4h5ioboee8uvp4nvez8p17utufwb6enp9j.png)
f3 = 1.502% approximately
![f4 = [{(1+y4)^(4)} / {(1+y3)^(3)}] - 1](https://img.qammunity.org/2021/formulas/business/college/lbr7a7hcxozg74k81iug8q66nxnabfgj2b.png)
f4 = 2.004% approximately
![f5 =[{(1+y5)^(5)} / {(1+y4)^(4)}] - 1](https://img.qammunity.org/2021/formulas/business/college/mdskuayxgizky3psw6oqg5erkw3v56yapk.png)
f5 = 2.506% approximately.
As implied one-year forward rates are observed to be rising and there is no uncertainty about future spot rates, future interest rates are expected to rise.
(C) Kindly check the second attached image below for the solution to question c
(d) The bond's price would be calculated by summing the Present Values(PVs) of the bond's future cash flows (in the form of annual coupon payments and face value redemption). The discount rate, however, should be the spot rates from the yield curve instead of a single promised yield to maturity.
Let bond price be Pm
Therefore, Pm = 20 / 1.005 + 20 / (1.0075)^(2) + 20 / (1.01)^(3) + 20 / (1.0125)^(4) + 1020 / (1.015)^(5) = $ 1024.872 approximately.
The bond's market value is above its par value, thereby implying that the bond is selling at a premium. This happens whenever the bond's discount rate (or spot interest rates in this case) is below the bond's annual coupon rate.