It is 2018. You decided to purchase a US treasury bond now. It matures in 8 year

Question

It is 2018. You decided to purchase a US treasury bond now. It matures in 8 years (in 2026), has a face value of S100,000, a coupon rate of 6 percent (as usually, you get the first coupon in a year, i.e. 2019) and a yield of 7 percent. a) Even before proceeding to calculations, you refresh what you learnt in the M&B; class and immediately realize that you would have to pay... rather than the face value of this bond (choose: more or less) b) Based on this information, you quickly calculate that you would have to pay $--for this bond. c) You purchased the bond back in 2017. It is 2018 now, and you've received the first coupon payment. Shortly after this, FED's actions led to an unexpected change in yield of all bonds. The yield for your bond now is 9 percent. What is the price of your bond now? d) but, if you actually feel completely indifferent to any changes in the bond price (even if it drops a lot) and yield, it must be the case that you planned originally to... (write a sentence or two explaining the reason when you feel not affected by this at all).

Explanation / Answer

Ans a)

Coupan Rate is less than Yield hence this bond is at discount therefore we have to py less rather than the face value of this bond

Ans b)

Market Value of Bond=6000/(1.07)^1+6000/1.07^2+...+106000/1.07^8=$97520.65

Ans c)

Market Value=6000+6000/1.09+6000/1.09^2+6000/1.09^3+6000/1.09^4+6000/1.09^5+6000/1.09^6+6000/1.09^7+106000/1.09^9=85003.3

Ans d)

we must have hedged ourselves from interest rate risk by buying IRS

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