(2 marks) c. Txo bonds (A and B.) have the following features Maturity Coupon Ra

Question

(2 marks) c. Txo bonds (A and B.) have the following features Maturity Coupon Rate Price (GHe) Yield to Maturity (Years) |(%) Bond (YTM) (%) Bond A 10 Bond B 10 These two bonds have a GHe 1,000 face value and an annual coupon frequency 1,352.2 5.359 964.3 10 5.473 . An investor buys these two bonds and holds them until maturity. Compute the annual return rate over the period, supposing that the yield curve becomes instantaneously flat at a 5.4% level and remains stable at this level during 10 years. i3 Marks) What is the interest rate level such that these two bonds provide the same annual return rate? In this case, what is the annual return rate of the two bonds? [2 Marks) ii.

Explanation / Answer

Bond A coupon=10%*1000=100

Bond A return=((100/0.054*(1.054^10-1)+1000)/1352.2)^(1/10)-1=5.3703%

Bond B coupon=5%*1000=50

Bond B return=((50/0.054*(1.054^10-1)+1000)/964.3)^(1/10)-1=5.4589%

Let interest rate at which both provide the same return be r

Hence,

((100/r*((1+r)^10-1)+1000)/1352.2)^(1/10)-1=((50/r*((1+r)^10-1)+1000)/964.3)^(1/10)-1

=>r=6.5105774358914%

Return by both bonds=5.6829%

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