You observe that the current three-year discount factor for default-risk free cash flows is 0.68....
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You observe that the current three-year discount factor for default-risk free cash flows is 0.68. Remember, the t-year discount factor is the present value of $1 paid at time t, i.e. D=(1+r)^-t, where r(t) is the t-year spot interest rate (annual compounding). Assume all bonds have a face value of $100 and that all securities are default-risk free. All cash flows occur at the end of the year to which they relate.
f) Consider discount factors such that d1 < d2 < d3. Explain why it would be odd to observe such a situation in a competitive market.
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