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4. The following table gives prices of bonds Bond principal Annual coupon Bond Price 100 100 100 100 Time to maturity years 1.00 2.00 3.00 4.00 0.0 6.2 7.0 8.0 98 95 101 104 a) Calculate zero rates for all maturities b) Calculate forward rates

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1 Steps 1. You just need to find the cashflows of the bond till maturity 2. Find the yield or IRR of the same using a Calc/spreadsheet. Cashflows CFO 3 Bond# 4 CF1 CF2 CF3 CF4 98 100 Zero Rate - 95 9% 101 6.2 106.2 Zero Rate 107 Zero Rate - 104 108 Zero Rate - 12 So, Zero rates are those rates which if will make your current bond price equals to a that of a zero coupon bond with same maturity and 13 same prinicipal 14 Forward rates 15 Forwards rates can be calculated using the zero rates using the following formula 16 1 Year Forward rate n year from now - 17 Zero rates calculated above 18 19 2.041% 21 Forward rates: 22 Year 23 11+D27)2/(1+D26)-1 21+D28)A3/(1+D27)42-1 - 3(1+D29)A4/(1+D28)A3-1 - 16.53% 1.94% 7.43% 25

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