Forward Price of a Contract on Zero-Coupon Bond
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You enter into a forward contract to buy a 10-year, zero coupon bond that will be issued in one year. The face value of the bond is $1,000, and the 1-year and 11-year spot interest rates are 3 percent per annum and 8 percent per annum, respectively. Both of these interest rates are expressed as effective annual yields (EAYs).
a. What is the forward price of your contract?
b. Suppose both the 1-year and 11-year spot rates unexpectedly shift downward by 2 percent. What is the price of a forward contract otherwise identical to yours?
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Solution Summary
This solution provides calculations for the forward price of a contract on zero-coupon bond using step by step formula and explanation.
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Bond will be issued in year 1, not now. So you need to calculate the bond price 1 year from now. For that you first need to calculate 10 year interest rate 1 year from now. This can be calculated using 1-year and 11-year spot interest rates.
A. What is the forward price of the contract?
We first need to calculate the 10 year interest rate at the end of year 1
1 ...
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