Coupon Bonds

1. The price of a 1-year zero coupon bond is 97% of the face value, the prices

of corresponding 2-year and 3-year bonds are 96% and 91%, respectively.

You are offered an opportunity to borrow $1m in year 1 (one year from now).

The loan requires annual coupon payments of 4% of $1m in years 2 and 3,

and you must repay the capital of $1m in year 3. Should you accept this

offer?

2. The Sharpe ratio and Jensen’s alpha of portfolio A are 0.10 and 0.004,

respectively. The risk-free rate is 3%, the average return on the market

portfolio is 7%, the variance of the market portfolio is 0.09, and the

correlation coefficient between A and the market portfolio is 0.7. What is the

expected return and the variance of A