TRADING CASE B02A
Trading rates under uncertainty
LEARNING OBJECTIVE
Value coupon and zero-coupon bonds when future spot rates are uncertain and traders receive private signals.
KEY CONCEPTS
Expected spot rates | Private information | Discounting | Arbitrage
HOW THE CASE WORKS
You trade the same four bonds as in B02, but the Year 2 and Year 3 interest rates are not known in advance. Each trader receives a true private message that rules out one possible rate.
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
Year 1 is 4%. Year 2 is equally likely to be 8%, 10%, or 12% (expected 10%). Year 3 is equally likely to be 14%, 16%, or 18% (expected 16%). Realized rates apply equally to borrowing and lending.
TRADING RULES
- Messages say that a Year 2 or Year 3 rate is not low, middle, or high.
- The message is always true. For example, 'Per3: Not high' rules out 18%.
- After trading starts, click Cp Bnd to see your message.
- If you are short a bond, you must make its payments when due.
AFTER TRADING CLOSES
Read your private message before deciding what a bond is worth.
The actual rate is applied to your closing cash.
Bond payments are made, and all positions are converted to cash after Year 3.
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.