Measuring term structure The following table shows the prices of a sample of U.S

Question

Measuring term structure The following table shows the prices of a sample of U.S. Treasury strips in February 2012. Each strip makes a single payment of $1,000 at maturity. a. Calculate the annually compounded, spot interest rate for each year. b. Is the term structure upward- or downward-sloping or flat? c. Would you expect the yield on a coupon bond maturing in February 2017 to be higher or lower than the yield on the 2014 strip? Price (%) 99.523% 98.937 97.904 96.034 Maturity February 2014 February 2015 February 2016 February 2017

Explanation / Answer

Now the price of Strip (expiring in Fen 2014) is $995.23 ( as it is 99.523% of face value)

Now to caluclate the annually compounded spot interest rate, enter the following in the financial calculator

PV = 995.23, n=2, PMT = 0, FV = -1000, calculate 1/y = 0.24%

For year 2015,

PV = 989.37, n=3, PMT = 0, FV = -1000, calculate 1/y = 0.36%

For year 2016

PV = 979.04, n=4, PMT = 0, FV = -1000, calculate 1/y = 0.53%

For year 2017

PV = 960.34, n=5, PMT = 0, FV = -1000, calculate 1/y = 0.81%

As is clear, term structure is upward sloping. Yield on a coupon bond maturing in February 2017 to be higher than the yield on the 2014 strip.

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