2012 Jun Q3(a)

Zero coupon bonds pay no interest - the just give one return when they are repaid (they are repaid at a premium, which is effectively interest). So, if you were only going to get one interest in 4 years time then you would want it to be equivalent to 3.8% per annum. However, if you are getting interest each year, then you would want the amount in 1 years time to be whatever rate the yield curve gave for 1 year, you would want the amount in 2 years time to be equivalent to what the yield curve gave for 2 years, and so on. Since we are talking about a fixed interest bond, then the fixed interest will be (in a sense) the average of each of those returns from the yield curve.

Did I miss something in the question that has already stated the 3.8% yield curve bond is zero coupon bond? Besides, is the yield curve that is the discounted factor equivalent to the interest rate of the bond? Thx!

The yield curve is showing the return that a zero coupon bond will give for different periods of time.

Got it!thx!

Great :-)