suppose the price of a one-year zero coupon bond is $900, and that the price of a two-year zero-coupon bond is $800. both bonds have $1,000 face value. what is the price of a two-year coupon bond with a 10% coupon rate?7

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01-12-2022
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suppose the price of a one-year zero coupon bond is $900, and that the price of a two-year zero-coupon bond is $800. both bonds have $1,000 face value. what is the price of a two-year coupon bond with a 10% coupon rate?7

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abhinavjh321 abhinavjh321 · Answer 1 · 2022-12-06T10:03:22+01:00

The price of a two-year coupon bond with a 10% coupon rate is $970

We build a replicating portfolio that has the same cash flows as the coupon bond with a 10% coupon rate. These cash flows are $100 in period 1 and $1100 at maturity. Therefore, we need to buy 0.1 units of the one-year zero coupon bond which amounts to a cost of $90. Furthermore, to generate the same cash flow in period 2 as for the coupon bond, we need to buy 1.1 units of the two-year zero coupon bond which requires a payment of $880. Together, the cost for the portfolio amounts to $90+$880=$970.

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