Spot rate calculation question interest, question, investor, following

karoliukas

I am felling a little ignorant right now & need some help understanding spot rate calculations. Here is the question:
An investor gathers the following information about a 3year, annualpay bond:
* Par value of $1,000
* Coupon of 8%
* Current price of $1,100
* 1year spot interest rate is 5%
* 2year spot interest rate is 6%
Using the above information, the 3year spot rate is closest to:
A) 4.37%
B) 4.27%
C) 8.20%
The correct answer is B) 4.27%.
The value of the bond is simply the present value of discounted future cash flows, using the appropriate spot rate as the discount rate for each cash flow. The coupon payment of the bond is $80 (0.08

spartan1

Hi SharpeCFA,
I assume you are using TI BA II plus,here is the calculation:
you already have the equation for PV of the Bond :
1,100= 80/(1.05)+ 80/(1.06)^2 + 1,080/(1 + 3year spot rate)^3
=>952.63=1080/ (1 + 3year spot rate)^3 let 3year spot rate=X
=>(1+X)^3=1080/952.63
=>(1+X)=(1.1337)^1/3 (cube root of 1.1337)
=>1.1337 press [Y^X] press [(] enter [1/3] press [) ]press [=]
=>1.0427 here’s the answer
Hope I made it clear.
Cheers
Dhruv

bchadwick

Thank you very much Dhruv! This makes complete sense now.