INSTRUMENT Treasury Bonds ______________________________________________________

Question

INSTRUMENT Treasury Bonds

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CURRENCY Australian dollars

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MATURITY DATE 21 October 2018 _________________________________________________________________________

COUPON 3.25% per annum, paid semi-annually in arrears, on the Face Value of the bonds _________________________________________________________________________

REDEMPTION Par

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COUPON PAYMENT DATES 21 April and 21 October in each year commencing on 21 April 2014, to and including the Maturity Date

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DENOMINATION $1,000 Face Value _________________________________________________________________________

(I already answered Question a. and got $1009.35, I would like to know how to answer Question b.)

a. Based on current market prices for this bond, it is possible to infer that investors require a return of 3% per annum, compounding semi-annually, on investments of this risk. Assuming this required rate of return remains constant through to the bond’s maturity date, how much do you expect this bond to trade for on 21 October 2014, immediately after the coupon interest has been paid to the holder of the bond?

b.Is this bond trading at par, at a premium or at a discount? What condition gives rise to this pricing relationship? Based on this pricing relationship, what can you infer about the risk of an investment in these bonds since they were first issued?

Explanation / Answer

b)

If the investor required rate of investor is less than the bond coupon payments, bond will trade at premium. In this case bond will quote at a price higher than the face value. Thus it has a inverse relationship. If required yield increases bond price will decrease and vice-versa.

Since, bonds are first issued investor cannot ascertain the performance of the past to evaluate the credit worthiness and repayment capacity of the issuer. But in this case, investor can rely on the credit reporting issued by the independent agencies like CRISIL in india.

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