Suppose the yield curve has the one-year spot rate (r (1)) at 5% and two-year spot...
Suppose the yield curve has the one-year spot rate (r (1)) at 5% and two-year spot rate (r(2)) at 7%. Which bond has the lowest price?
A - 1-year zero coupon bond with face value $100
B- 2-year zero coupon bond with face value of $100
C- 2-year zero coupon bond with 2% annual coupon and face value $100
D- 2-year coupon bond with 10% annual coupon and face value $50
Homework Answers
The correct answer is B - 2-year zero coupon bond with face value of $100.
Higher the spot rate, lower the price.
Note the option C is an incorrect statement. By definition, a zero-coupon bond does not pay coupons.
Option D is incorrect because, if the coupon rate is 10%, which is more than the 2-year spot rate, then it must sell at a premium.
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