Cougars Case

2291 words - 10 pages
1. Why have riskless zero-coupon bonds been so successful with investors?

Zero-coupon bonds have been successful because they can be purchased by investors at a deep discount from their face value and because the investor knows exactly how much they will collect in a lump sum at the bond’s maturity date. Zeros do not pay interest during the life of the bond and at maturity; the investor receives an amount equal to the initial investment plus the imputed interest. Zeros are offered for long-term maturities, so that investors can use them to plan for long-term goals and to diversify their portfolio. Ultimately, zero-coupon bonds are successful because they are sold at a deep discount, so an investor can spend a small amount of money that can grow over many years.

2. What relationship do the prices of riskless zero-coupon bonds have with the term structure of interest rates?

Longer-term interest rates are higher than shorter-term interest rates. This reflects the higher inflation-risk premium that investors demand for longer-term bonds. The term structure of interest rates is graphed as though each coupon payment of a riskless bond were a zero-coupon bond that matures on the coupon date.

3. How are spot, strip and coupon yield related?

Treasury STRIPS convert each coupon and principal payment into a separate zero-coupon security. The Treasury yield curve is obtained from the prices of Treasury strips. Strips are essentially zero-coupon bonds which are traded for a variety of maturities. From the strip prices, you can directly obtain the yield curve. The spot rates are w ...

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