Question

(8 points) Consider two coupon-bonds, one is a 3-year $100 par-valued bond with 5% annual coupon payment and annual yield rate 4%; the other is a 3-year $100 par-valued bond with 5% annual coupon payment and annual yield rate 6%. Which one do you think is a better investment and why?

Answer 1

Option 1

Face Value = $100 ,coupon payment (i) =5%, yeild =4%

Calculating PV of bond using yeild ie pv ratio = 4%

Interest = 10085%=5

year	interest	PV factor	Present Value
1	5	0.9615	4.8075
2	5	09246	4.623
3	105	0.8890	93.35

Total of PV =102.78

Option 2

Face Value = $100 ,coupon payment (i) =5%, yeild =6%

Calculating PV of bond using yeild ie pv ratio = 6%

year	Interest	PV factor	PV
1	5	0.9434	4.717
2	5	0.9426	4.45
3	105	0.8396	98.658

Total PV = 107.825

When the price of the bond is beneath the face value, the bond is "trading at a discount." When the price of the bond is above the face value, the bond is "trading at a premium." Therefore Option 1 is better since the premium is less on it.