Asset pricing

a) How are bonds with various maturities related to each other? State the two hypotheses that govern

this relationship. What do these hypotheses predict about interest rate changes in an economy?

[7 marks]

b) How can you test these hypotheses empirically? Write in words how you can interpret the coefficients

in these regressions. Do these hypotheses work, i.e., do they explain the data well? If yes, why? If

no, why not?

[7 marks]

c) The term structure of interest rates in the economy is given by the following schedule:

Maturity Rate (per annum)

1 0.72%

2 0.81%

3 1.02%

4 1.23%

i. What is the price of a £100, 4-year, 5% coupon bond?

ii. What is the yield to maturity of a £100, 2-year, 10% coupon bond?

Taidot: R-ohjelmointikieli, Algoritmi, Asset Management

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