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  • You are quoted at the following market prices

    Do you have a query about the market price quoted for zero coupon bonds? want to determine the fair froward price of the same? Find responses from experts on this page.

    You are quoted at the following market prices V (T) for zero-coupon bonds per T-year unit:
    V (2) = 0.80 and V(4) = 0.60.
    (a)explain what is meant by a zero-coupon bond per unit T-year.
    (b) subject to the absence of arbitration, settlement on-site rats2, and Fair Forward Rate f24. [4]]
    You want to sign a forward contract for the purchase of 20 tons of steel in 4 years.
    The current price of steel is a ton.
    (c) briefly explain what is meant by a forward contract for the purchase of steel.
    (d) assuming no arbitration, determine the fair forward price of the contract
  • Answers

    1 Answers found.
  • Coupon rate is another term for the interest. So, a zero coupon bond is a bond instrument which does not pay any interest to the owner of the bond but it is available in the market or at the time of initial issue at a discounted price. Then the person has a choice to sell it in the market when its price rises or at the time of maturity.

    The future and contract trading in zero coupon bonds is based on the simple calculations of yield to the maturity or other aspects of market fluctuations of bond prices. For example if a zero coupon bond having face value of Rs 1000 is quoting at Rs 700 and there are 5 years left for its maturity then in general we can expect a slight rise in its market price which will have a tendency to reach Rs 1000 in 5 years time. So we can represent its expected approximate market value by V(time in years) or V(T). Based on simple calculations we can with basic Mathematics find out that it translates to 7% compounded rate of interest (CARG) and we can expect about a market value of about Rs 750 (using 700 + (700 x 7 / 100)) after 1 year. Which can be represented as V(1). Market value after 2.4 years can be represented as V(2.4). What you have mentioned is market value expected after 2 years V(2) and 4 years V(4) and values are assuming a face value of 1.0

    Now, I am coming to your query about the commodity futures. You want to make a buy forward contract for 20 tons of steel after 4 years. This is a bit tricky because we do not know how the steel prices will change with time. It requires some basic knowledge of the commodity market as well as expected fluctuation in a particular commodity. Based on that speculation one can buy a forward contract by paying margin amount and then exercising the option as per the condition of the contract. Remember, that margin money is to be paid to avoid huge losses and that is the advantage of future contracts. In favourable circumstances same contract can fetch good gains also.

    Knowledge is power.

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