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    Forward contract on zero coupon bond

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    You enter into a forward contract to buy a 5 yr, zero coupon bond that will be issued in one year. The face value of the bond is 2,000, and the 1 year and 10 year spot interest rates are 2 percent per annum a 6 percent per annum. Both of these interest rates are expressed as effective annual yields.

    What is the forward price of your contract?

    Suppose both of the spot rates unexpectedly shift downward by 1 percent. What is the price of a forward contract otherwise identical to yours?

    Need help answering these questions:
    a. What financial concept or principle is this problem asking you to solve?
    b. What are some business decisions that a manager would be able to make after solving the problem?
    c. Is there any additional information missing from the problem that would enhance the decision-making process?
    d. Without showing mathematical calculations, explain in writing how you would solve the problem.

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    Solution Preview

    You enter into a forward contract to buy a 5 yr, zero coupon bond that will be issued in one year. The face value of the bond is 2,000, and the 1 year and 10 year spot interest rates are 2 percent per annum a 6 percent per annum. Both of these interest rates are expressed as effective annual yields.

    What is the forward price of your contract?

    Suppose both of the spot rates unexpectedly shift downward by 1 percent.
    What is the price of a forward contract otherwise identical to yours?

    Need help answering these questions:
    a. What financial concept or principle is this problem asking you to solve?

    The term structure of interest rate
    How the expected 5 year spot rate one year from now depends on the 1-year and 6-year spot interest rates

    Another financial concept is the Time Value of money. Any cash flow in the future has a present value that depends ...

    Solution Summary

    Answers questions on forward contracts on zero coupon bonds.

    $2.19

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