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QUESTION

Estimate term structure of discount factors, spot rates and forward rates by using data on five semi-annual coupon paying bonds with $100 face value each. The bonds, respectively, have 1.25, 5.35, 10.

Estimate term structure of discount factors, spot rates and forward rates by using data on five semi-annual coupon paying bonds with $100 face value each. The bonds, respectively, have 1.25, 5.35, 10.4, 15.15, and 20.2 years to maturity; pay coupon at annual rates of 11, 12, 13, 14 and 15 percent of face value; and are trading at quoted spot market prices in dollars of 105, 106, 107, 108, and 109. Specify the discount factor function d(t) by a third degree polynomial with unknown parameters a, b, and c.  Using estimated d(t) function, determine spot rate and forward rate functions by assuming half-year compounding. Then write the values of the following based on your estimation. 

1. Coefficient of parameters a, b and c in first bond price equation

2. Coefficient of parameters a, b and c in second bond price equation

3. Coefficient of parameters a, b and c in third bond price equation

4. Coefficient of parameters a, b and c in fourth bond price equation

5. Coefficient of parameters a, b and c in fifth bond price equation 

6. Parameters a, b and c 

7. Current price of a dollar at 5th, 7th, 10th and 15th year

8. Spot rate for terms 2, 5, 10, and 17 year

9. Forward rate for half year periods:

  • 2.5 - 3.0 years
  • 5.5 - 6.0 years
  • 10.5 - 11.0 years
  • 15.5 - 16.0 years 
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ANSWER

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