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The following information was available as of the close of business June 1, 2004, on government of Canada bonds. Coupon 7.00%

Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securiti

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Answer #1

You have asked multiple unrelated questions in the same post. I have addressed the first question. Please post the balance questions, separately, one by one.

First Question:

Let the one year rate in first, second and third year be respectively a, b, and c

Hence, a = yield of one year maturity bond = 2.62%

Price of two year maturity bond = 113.93 = C / (1 + a) + (C + 100) / [(1 + a)(1 + b)]

where C = coupon = 10.7% = 10.7% x 100 = 10.7

Hence, 113.93 = 10.7 / (1 + 2.62%) + (10.7 + 100) / [(1 + 2.62%)(1 + b)]

Hence, b = 4.22%

Price of three year maturity bond = 107.61 = C / (1 + a) + C / [(1 + a)(1 + b)] + (C + 100) / [(1 + a)(1 + b)(1 + c)]

where C = coupon = 8.7% = 8.7% x 100 = 8.7

Hence, 107.61 = 8.7 / (1 + 2.62%) + 8.7 / [(1 + 2.62%)(1 + 4.22%)] + (8.7 + 100) / [(1 + 2.62%)(1 + 4.22%)(1 + c)]

Hence, c = 11.69%

Hence, your final answers should be:

Interest rate
2nd Year 4.22%
3rd Year 11.69%
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