TRADING CASE B02
Bond prices and the yield curve
LEARNING OBJECTIVE
Learn how one-, two-, and three-year rates and arbitrage relationships determine bond prices.
KEY CONCEPTS
Yield curve | Cash matching | Arbitrage | Market making and taking
HOW THE CASE WORKS
In Year 1, you can trade one coupon bond and three zero-coupon bonds. Each zero-coupon bond pays 100 in its maturity year. Trading takes place on Day 1 of each year. After Year 3, all positions are converted to cash.
BOND PAYMENTS
| Instrument | Year 1 | Year 2 | Year 3 |
|---|---|---|---|
| 10% coupon bond | 10 | 10 | 110 |
| 1-year zero | 100 | 0 | 0 |
| 2-year zero | 0 | 100 | 0 |
| 3-year zero | 0 | 0 | 100 |
INTEREST RATES
The annual rates are 4% in Year 1, 10% in Year 2, and 16% in Year 3. The same rate applies to savings and borrowing. No interest is added during a trading session.
TRADING RULES
- You may enter bids and asks or trade at prices already shown in the market.
- A market-limit order sets the highest buy price or lowest sell price you accept.
- If you finish the day short, you must make any bond payments due.
- If you close a short position during the day, only the trading gain or loss remains.
AFTER TRADING CLOSES
Interest is applied to your closing cash.
Coupons and face values due that year are paid.
The next year's trading begins with the bonds that have not yet matured.
PERFORMANCE: Trading bonus (grade cash) per trial = 0.0001 x closing market cash. Positive wealth adds grade cash; negative wealth subtracts it. Results accumulate across independent trials.