Suppose that all investors expect that interest rates for the 4 years will be as follows: If you have just purchased a 4-year zero-coupon bond, what would be the expected rate of return on your investment in the first year if the implied forward rates stay the same? (Par value of the bond = $1,000.)
A)5%
B)3%
C)9%
D)10%

Question

Suppose that all investors expect that interest rates for the 4 years will be as follows:  If you have just purchased a 4-year zero-coupon bond, what would be the expected rate of return on your investment in the first year if the implied forward rates stay the same? (Par value of the bond = $1,000.)
A)5% 
B)3% 
C)9% 
D)10%

Quizplus · Accepted Answer

The expected rate of return on a zero-coupon bond is equal to the forward rate for that period. For a 4-year zero-coupon bond, the forward rate for the first year is given by the first implied forward rate of 3%. Therefore, the expected rate of return on the investment in the first year is 3%.

Suppose That All Investors Expect That Interest Rates for the 4