Assume you have a one-year investment horizon and are trying to choose among thr

Question

Assume you have a one-year investment horizon and are trying to choose among three bonds. All have the same degree of default risk and mature in 9 years. The first is a zero-coupon bond that pays $1,000 at maturity. The second has an 7.1% coupon rate and pays the $71 coupon once per year. The third has a 9.1% coupon rate and pays the $91 coupon once per year.

If all three bonds are now priced to yield 7.1% to maturity, what are their prices? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

If you expect their yields to maturity to be 7.1% at the beginning of next year, what will their prices be then? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

What is your rate of return on each bond during the one-year holding period? (Do not round intermediate calculations.Round your answers to 2 decimal places.)

Assume you have a one-year investment horizon and are trying to choose among three bonds. All have the same degree of default risk and mature in 9 years. The first is a zero-coupon bond that pays $1,000 at maturity. The second has an 7.1% coupon rate and pays the $71 coupon once per year. The third has a 9.1% coupon rate and pays the $91 coupon once per year.

Explanation / Answer

a)

Zero

7.1% Coupon

9.1% Coupon

  Current prices

540$        

1000.79$     

1130.59$      

At zero:

Bond price= 0 PA(7.1%,9 years)+ 1000PF(7.1,9 Years)

                  = 0+540=$ 540

At 7.1% = 71PA (7.1%, 9 years)+ 1000PF(7.1,9 Years)

             = 71x6.49 + 1000x.54 = $1000.79

At 9.1% = 91PA (7.1, 9 years)+ 1000PF(7.1,9 Years)

               = 91x 6.49 + 1000x 0.54 = $1130.59

b.1)

Zero

7.1% Coupon

9.1% Coupon

  Price one year from now

580$      

1002.45$      

1121.45$      

At zero:

Bond price= 0 PA(7.1%,8 years)+ 1000PF(7.1,8 Years)

                  = 0+580=$ 540

At 7.1% = 71PA (7.1%, 8 years)+ 1000PF(7.1,8Years)

             = 71x5.95 + 1000x.58 = $1002.45

At 9.1% = 91PA(7.1%, 8 years)+ 1000PF(7.1,8Years)

               = 91x 5.95 + 1000x 0.58 = $1121.45

b.2)

Zero

7.1% Coupon

9.1% Coupon

  Rate of return

0 %      

7.26 %      

7.30 %      

Zero:

HPR= 0 +[580-540]/540x100= 7.41%

At 7.1%: HPR= 71+[1002.45-1000.79]/1000.79x100= 7.26%

At 9.1%: HPR= 91+[1121.45+1130.59]/1121.45x100=7.30%

Zero

7.1% Coupon

9.1% Coupon

  Current prices

540$        

1000.79$     

1130.59$      

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