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The yield to maturity on 1-year zero-coupon bonds is currently 6%; the YTM on 2-year zeros is 7%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon rate of 8.5%. The face value of the bond is $100.
a. At what price will the bond sell? Price=?
b. What will the yield to maturity on the bond be? Yield to maturity=?
c. If the expectations theory of the yield curve is correct, what is the market expectation of the price that the bond will sell for next year? Price=?
d. Recalculate your answer to (c) if you believe in the liquidity preference theory and you believe that the liquidity premium is 1.5%. Price=?
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