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1) Consider two bonds with identical face value of $100 that pay semiannual coup

ID: 2653524 • Letter: 1

Question

1) Consider two bonds with identical face value of $100 that pay semiannual coupons. You have the following information:

Bond

Coupon Rate

Maturity

YTM

A

6.0%

5 years

5.5%

B

7.0%

15 years

6.0%

Compute the price of bonds A and B.

Suppose that you have $100,000 that you want to invest in bonds. Six months later, bond A trades for $103, and bond B trades for $109. Compute your annualized HPR if:

You invest everything in A

You invest everything in B

You allocate 60% to bond A and 40% to bond B

(You can assume that you can buy fractions of each bond if necessary).

Bond

Coupon Rate

Maturity

YTM

A

6.0%

5 years

5.5%

B

7.0%

15 years

6.0%

Explanation / Answer

Answer :

Calculation of price of bonds:

Bond A=6*4.27028+100*0.765134

=126.386814

Bond B= 7*9.7122489+100*0.417265055

=109.7122

Annualized HPR =

{[(Income + (End of Period Value – Initial Value)] / Initial Value+ 1}1/t – 1

Investing in A= {6+(103-100)/100+1}1/6-1

=-33.167%

Investing in B= {7+(109-100)/100+1}1/6-1

=-26.441%

Proportion=-33.167%*0.6+(-26.441*0.4)

=-30.4764%