Question Description
Given that the current 1-year spot rate is 3%, and 1f1 is 3.5% and investors require a liquidity premium on short-term bonds such that the expected annual return on a 2-year bond is 0.25% per year lower than the expected return on a series of two, 1-year bonds, What is the current market price of a 2-year bond that pays a 4% coupon rate (annual payments) and what is the expected price of this bond one year from today? If you buy the bond today, hold it for one year, collect its first coupon payment, then immediately resell it at the expected selling price, what is your expected return?
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