The yield to maturity on one-year zero-coupon bonds is currently 7%, and the yield to maturityon two-year zeros is 8%. The Treasury plans to issue a two-year maturity coupon bond, payingcoupons once per year with a coupon rate of 9%. The face value of the bond is $100.
(a) At what price will the bond sell?
(b) What will the yield to maturity on the bond be?
(c) If the expectations theory of the yield curve is correct, what is the market expectation of theprice that the bond will sell for next year?
(d) Recalculate your answer to (c) if you believe in the liquidity preference theory, and that theliquidity premium is 1%.