Justify your answer. a) True or False: When the coupon rate of a coupon bond is
ID: 2807171 • Letter: J
Question
Justify your answer.
a) True or False: When the coupon rate of a coupon bond is less than the market
interest rate then the bond is a discount bond. You may assume coupons are paid annually.
b) True or False: The price of Apple stock is $95. A call option on Apple stock
with exercise price $100 and that expires in 6 months costs $3 and a put option with the
same exercise price and expiration date costs $6. The only risk-free asset traded among
investors in this economy is a 6-month maturity bond with a 1 percent interest rate. An
investor is able to conduct arbitrage by buying the stock and the put, selling the call
receiving a risk-free loan.
c) True or False: In a world of certainty if the yield to maturity of a 2 year zero
coupon bond is 8 percent and the yield to maturity of a 1 year zero coupon bond is 7
percent then the yield curve of the 2 year zero coupon bond is a decreasing function.
Explanation / Answer
Answer A
True
When the bonds pay a lower coupon than the market interest rate, to arrive at the yield to maturity equal to market interest rate, bonds are sold at a discount. A lower price of the bond ensures the same rate of return (market return) even with the lower coupon rate.
To calculate the value of a bond, the cash flows generated by the bond is discounted at the market interest rate. If the market interest rate is greater than coupon rate, it will decrease the sum of PV of bonds below its par value.
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