Problme 1.
a. Suppose a bond was issued several years ago when the interest rate was 7%. The bond's annua coupon rate was thus set at 7%. With three years left in the bond's life, the interest rate is 8% per year. What will be the price of the bond with three years left?
b. What will the price of the above bond be when there is two years left to maturity?
c. What will the rate of return for the above bond be ifyou hold the bond during the third year? Make sure you show your calculation.
Problem 2.
a. Assume you buy a two-year bond with an 8% coupon rate and the current interest rate is 8%. How much money will you have after two years if interest rates stay at 8% and you reinvest all interest payments?
b. Assume that right after you buy the bond in 2a the interest rate drops to 7% and you reinvest the interest payments at 7%.
What is your realized VIM?