An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $826.45 per $1,000 for the bond. The current yield on a one-year bond of equal risk is 9 percent, and the one-year rate in one year is expected to be either 11.60 percent or 10.40 percent. Either rate is equally probable.
-If the manager buys a one-year option with an exercise price equal to the expected price of the bond in one year, what will be the exercise price of the option?
A)$862.10.
B)$743.23.
C)$900.93.
D)$811.70.
E)$917.36.

Question

Quizplus · Accepted Answer

The exercise price of the option is the expected price of the bond in one year. The bond's price in one year is calculated using the expected one-year rate in one year. The expected rate is the average of 11.60% and 10.40%, which is 11%. The bond's price in one year is $826.45 * (1 + 0.09) = $900.93.

An FI Manager Purchases a Zero-Coupon Bond That Has Two