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Q-10-38I

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Essentials Of Investments
Found in: Page 332
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

Question: Assume you have a one-year investment horizon and are trying to choose among three bonds. All have the same degree of default risk and mature in 10 years. The first is a zero-coupon bond that pays $1,000 at maturity. The second has an 8% coupon rate and pays the $80 coupon once per year. The third has a 10% coupon rate and pays the $100 coupon once per year.

a. If all three bonds are now priced to yield 8% to maturity, what are their prices?

b. If you expect their yields to maturity to be 8% at the beginning of next year, what will their prices be then? What is your rate of return on each bond during the one-year holding period?

Answer

a.

Zero

8% coupon

10% coupon

Current Prices (A)

$463

$1000

$1134.20

b.

Rate of return (Income / Current Prices)

8.00%

8.00%

8.00%

See the step by step solution

Step by Step Solution

Step 1: Given information

Maturity period = 10 Years

Zero coupons matures at $1000

Coupon income for all three is $0, $80 and $100

Step 2: Calculation of Current prices

If the yield to maturity of three bonds is 8% at the beginning of the next year, it would be calculated using 9 years of maturity in place of 10 years.

Therefore,

Zero

8% coupon

10% coupon

Current Prices (A)

$463

$1000

$1134.20

Step 3: Calculation of rate of return 

Zero

8% coupon

10% coupon

Current Prices (A) PV= (0.8, 10, PMT, 1000)

$463

$1000

$1134.20

Price one year from now (B) PV= (0.8, 9, PMT, 1000)

$500.25

$1000

$1124.94

Price increase (B-A)

$37.06

$0.00

$-9.26

Coupon income (Given)

$0.00

$80

$100

Income (Price increase + Coupon Income)

$37.06

$80

$90.74

Rate of return (Income / Current Prices)

8.00%

8.00%

8.00%

Most popular questions for Business-studies Textbooks

Spice asks Meyers (see the previous problem below) to quantify price changes from changes in interest rates. To illustrate, Meyers computes the value change for the fixed-rate note in the table. He assumes an increase in the interest rate level of 100 basis points. Using the information in the table, what is the predicted change in the price of the fixed-rate note?

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