Question

Bonus Problem 1 (Optional, 30 marks) The following table shows the market information of three straight term bonds available in the market. Bond term Face value Redemption Coupon Market value rate price (Frequency) Bond A n years 2000 2200 5% 2075.3 (Annual) Bond B 2n years 1000 1100 1180.6 (Annual) Bond C 3n years 1000 1100 5% 1150.2 (Annual) An investor wishes to invest his/her capital in one of the above bonds. Which bond should he choose? Explain your answer. 5%

Answer 1

Answer- In this ques let us assume n= 1

so, Time of bond A = 1 year

Bond B = 2 year

Bond C =3 year

There is negative relation with yield to maturity and market price, because as we are discounting future value to get present value or market price. Thus more discounting rate, less market price or current price.

But in case of Bond A there is positive relation between YTM & price , thus it is cheaply available as compare to other bonds.
Answear Bond A con st on Face value h ome on face value) given on face ralwe) always be (because interest Coupon (1 ) PV = 2075.3 face nolues 2000 By equatum :- Fro Pv (148) t on PV IV 075-3 2200 HOU . (1+r)' It of 330 20753 (148) = 1208918 8 1089978-1 Y Olo 8918 04 Y- Quelo 8211; In this case YTM > Coupon , so current value price should fall below face rowe (ne. But in the it is greater than fore vawe 1 cheeper as compared to other bonds. or market M.V < Forevolus to this bond Bond B ( 1000 x 5 = 50) T= 2 years FY floo Coupon Role = 51 on face valuerie Pron market price = 11806 face rawe = 1000 Erte = PV (1+r)t PV = fr+ch (17) Bond = CF - CF2 Parce of Bond - 1 th) (1Hoje Where CF - cash flow

(By solving equation) 1180.6= 50 to) 1150 (142) rs 0.835 4. In thu Hence YTH < Coupon nate parce > Future Value T Bond C) T= 3 years EV = 100 PV = 1150.2 Coxx lovo Face volue = 1too - 50 Coupon role - 57 om fore yowe me.Coxx love) Pane 978and 1150.2 (148P (tr) + 50+ 1100 Cars By solving equation on Colwlatona 8= 2.93% In this case also YTN < Coupon rate . Hence Toniwsion > Market Paule Tolone you But in Bond A YTM <Coupon nate Coment pure < Future value Hence we should buy this because it us cheeply available as compared to other bonde.