Problems: 1. Consider the following zero-coupon yields on default free securitie

Question

Problems:

1. Consider the following zero-coupon yields on default free securities:

Maturity (years)

1

2

3

4

5

Zero-Coupon YTM

5.80%

5.50%

5.20%

5.00%

4.80%

What is the price today of a two-year, default-free security with a face value of $1000 and an annual coupon rate of 5.75%? Does this bond trade at a discount, premium, or at par?

2. Explain why the expected return of a corporate bond does not equal its yield to maturity.

3. The prices of several bonds with face values of $1000 are summarized in the following table:

Bond A B C D

Price $972.50 $1040.75 $1150.00 $1000.00

                  For each bond, state whether it trades at a discount, at par, or at a premium.

4. Suppose the yield on German government bonds is 1%, while the yield on Spanish government bonds is 6%. Both bonds are denominated in euros. Which country do investors believe is more likely to default? Why?

Maturity (years)

1

2

3

4

5

Zero-Coupon YTM

5.80%

5.50%

5.20%

5.00%

4.80%

Explanation / Answer

1) According to the Bond Value Theorems if the required rate is less than the coupon, then the Bond will trade at the premium.

2) Since Corporate bonds are default bonds ,hence the discount rate is heightened due to uncertainity factor which slightly depresses the return as comapred to Yield to maturity.

3) A is at Discount, B is at premium,C is at premium, D is at Par

4)Spain is more likely to default, Since the bond yield is more , this indicates the investors seek more returns or yield to stay invested in spanish bonds this is a sort of compensation for taking more risk

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