The three U.S. Treasury bonds described below are traded in the market and pay annual coupons. Assume that the par amount for each bond is $100.
Bond Maturity (Yr) Coupon Rate (%)
A) Year 1 3.5%
B) Year 2 5.0%
C) Year 3 4.5%
Assume that the 1-year interest rate is 3%, the 2-year interest rate is 4%, and the 3-year interest rate is 5%.
(a) Write out each bond's cash flow for each year.
(b) Find each bond's price.
(c) Suppose the Treasury plans to issue a new 3-year note with a $1,000 face value and annual coupons. What coupon rate would they need to set for the bond to initially trade at a price of $1,000?