the solutions is: Please show steps (7) Martin Maradiaga was considering two bon

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the solutions is:

Please show steps

(7) Martin Maradiaga was considering two bond offerings for purchase on March 1, 1995. Each had a purchase price of $10,000. Bond A was an "inf adjusted" 4% ten-year $10,000 bond with annual coupons, the coupon pay- ments were to be based on March 1, 1995 dollars so that the inflation-adjusted coupon rate was 4% and the bond would be redeemable at an amount worth $10,000 in March 1, 1995 dollars. Bond B was a 7% ten-year $10,000 par- value bond with annual coupons offered by Delta Diagnostics. Which should Mr. Maradiaga purchase if he forecasts that inflation will be at a level rate of 2.75%? Why? If inflation is actually at 2.2%, find the inflation-adjusted yield on each bond. (6

Explanation / Answer

Since bond A is already inflation adjusted so its yield is equal to coupon rate of bond that is 4%.

for bond B, if inflation rate is 2.75% then inflation adjusted yield is calculated below:

Inflation adjusted yield = (1 + 7%) / (1 + 2.75%) - 1

= 1.0413625 - 1

= 4.13625%

if inflation rate is 2.75% then inflation adjusted yield in bond is 4.13625%.

Again.

for bond B, if inflation rate is 2.22% then inflation adjusted yield is calculated below:

Inflation adjusted yield = (1 + 7%) / (1 + 2.22%) - 1

= 1.0469667 - 1

= 4.69667%

if inflation rate is 2.22% then inflation adjusted yield in bond is 4.69667%.

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