An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $78 per $100 for the bond. The current yield on a one-year bond of equal risk is 10 percent, and the one-year rate in one year is expected to be either 16.65 percent or 15.35 percent. Either rate is equally probable.
a. Given the expected one-year rates in one year, what are the possible bond prices in one year? With calculations please.
b. Based on the above information, what is the yield to maturity for the two-year bond if held to maturity?