Problem 4 - Bonds You recently inherited from your late uncle a US government bo

Question

Problem 4 - Bonds

You recently inherited from your late uncle a US government bond that matures December 31, 2025. The bond has a face value of 20,000 USD, which is equal to its redemption value. It pays an annual interest of 8%, payable semi-annually (i.e. as 4%) on June 30 and December 31 of each year. Answer the following question by performing your calculations both analytically and by using the relevant Excel functions.

If you wish to earn a 5% semi-annual return on your bond investment, what is the value of this bond to you on July 1, 2016?

If the bond trades for 17,988 USD in the market on July 1, 2016, would you sell it? Shortly explain why.

In reference to part (b) above, if there was a 3% transaction fee you have to pay to the tradinghouse, would you sell it, or buy more of the bond?

If bond yield rates (per semi-annum) in the market are currently around 4.78%, what market price does this predict for your bond on July 1, 2016?

If the bond trades for 17,988 USD in the market on July 1, 2016, what is the implied bond-yield rate?

Explanation / Answer

The calculation of present value of bond having 19 intervals and bond interest of $800 ($20,000 * 4%) From 1st June 2016 to 31st Dec. 2025=19 intervals coupon amount per interval $               800 Maturity $         20,000 Intervals 19 Coupon rate 4% YTM 5% Present value $17,582.94 ($17,582.94) Value of bond=$17,582.94 If the bond trades for $17,988 then we can sell it because the value of the bond is $17,582.94 and the bonds are trading at premium. If the transaction fee of 3% is charged then the selling price would be $17,988-($17,988*3%)=$17,448.36 The bond value is more than the traded value therefore the bond should not be sold off. If bond yield rate in the market are currently around 4.78% then the market value of the bond would be as under: YTM 4.78% Intervals 19 Coupon amount $800 Coupon rate 4% Future value $20,000 Present value $18,080.43 ($18,080.43) If the bond yield rate is 4.78% then the market value of the bond would be $18,080.43. If the market rate of bond is $17,988 then the bond yield rate would be as under: Bond Yield rate=coupon amount/market rate of bond                                '=$800/$17,988                               '=4.45% The bond yield rate would be 4.45%

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