You may complete the exercise using Excel (the efficient way) or word. A/ Assume

Question

You may complete the exercise using Excel (the efficient way) or word.

A/ Assume that you are trying to choose which of 3 bonds to buy:

A zero coupon bond

A 5% coupon bond

An 8% coupon bond

Each has a face value of $1,000. They all mature in 10 years, have the same default risk and pay any coupons annually. There are no other special provisions.

a. If the current market rate of interest is 4%, what are the prices of the three bonds?

b. If your holding period is one year only, what will be the holding period rate of return for each bond?

B/ Suppose you are Investing money in an RESP (Registered Educational Savings Plan) to meet your child’s post-secondary schooling expenses. You expect you will have to pay out $20,000 per year for 4 years starting 9 years from now. We will just consider the first year’s obligation of $2,000. You have available the three bonds described in Question 2 above.

a. Calculate the current price and duration of each bond.

b. Calculate the shares of Bonds 1 and 3 in an optimal immunized portfolio.

Explanation / Answer

Dear student We will summariase the question first Face value of the bond = $1000 Life of the bond = 10 years Current market rate = 4% Options given Option1 = Zero coupon bond Option2 = 5% bond Option3 = 8% bond A) a) Computation of current prices of the bonds at 3 options Year PVF @ 4% option 1( Zero coupon bond) Option 2( 5% Bond) Option 3 (8% Bond) Amount present value amount present value Amount Present value 1 0.961538 0 0 50 48.07692308 80 76.92308 2 0.924556 0 0 50 46.22781065 80 73.9645 3 0.888996 0 0 50 44.44981793 80 71.11971 4 0.854804 0 0 50 42.74020955 80 68.38434 5 0.821927 0 0 50 41.09635534 80 65.75417 6 0.790315 0 0 50 39.51572629 80 63.22516 7 0.759918 0 0 50 37.99589066 80 60.79343 8 0.73069 0 0 50 36.53451025 80 58.45522 9 0.702587 0 0 50 35.12933678 80 56.20694 10 0.675564 0 0 50 33.77820844 80 54.04513 10 0.675564 1000 675.5641688 1000 675.5641688 1000 675.5642 PRESENT VALUE 675.5641688 1081.108958 1324.436 b) Lets assume selling price after one year is $1000 PARTIUCLARS OPTION1 OPTION2 OPTION3 Purchase price 676 1081 1321 Interest 0 50 80 Selling price 1000 1000 1000 Total return 1000 1050 1080 Rate of return 47.92899 -2.86771508 -18.24375473

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