The annual coupon rate on a 1-year treasury bond is 5.5%.The coupon on a 2-year treasury bond is 5.8%.What is the continuously compounded yield on a 2-year zero coupon bond?

Question

Quizplus · Accepted Answer

We can use the formula for the pricing of a coupon bond to find the yield on the zero coupon bond. Let F be the face value of the bond and r be the continuously compounded yield on the 2-year zero coupon bond. Then we have:

F = (5.5/100)F/(1+r) + (F + (5.8/100)F)/(1+r)^2

Simplifying this equation, we get:

1 + r = [(100 + 5.8)/100]/[(100 + 5.5)/100]^2

1 + r = 1.058/1.055^2

1 + r = 1.056492

r = 5.6492%

Therefore, the answer is B) 5.65%.

The Annual Coupon Rate on a 1-Year Treasury Bond Is