Question

hi there! i was wondering if some one could help me with 3.4 and 3.5? thnk you so much!

(i) A one year zero coupon bond, with a par value of £100 (ii) A five year UK gilt, with a coupon rate of 6% and a face value of £100 (coupons are paid annually) (iii) A three year UK gilt, with a coupon rate of 10% and a face value of £100 (coupons are paid semi-annually) The yield to maturity on the UK gilts are Matuity 2 years 3 years 4 years 5years 10 years 25 years 50 years Yield 0.5% | 1.23% | 1.58% | 2.21% | 2.89% | 3.27% | 4.88% The yield to maturity on the one-year zero coupon bond is 0.4% REQUIRED Q3.1. Calculate the price bond (i) (2%) Q3.2. Calculate the price of bond (ii) (3%) Q3.3. Calculate the price of bond (ii) (5%) Alternatively you consider investing in a German Bundesanleihen, a 10 year German government bond. The bond is currently trading for 854.25 If you go ahead and purchase the bond, it will pay annual coupons at a rate of 5%, have a maturity of 10 years and a par value of 1,000 Q3.4. What is the current yield to maturity on this German bond? Comment on your answe (13%) Q3.5. "Inflation' and the risk of default are two concepts that affect bond holders Explain the meaning of each concept and highlight why bondholders could be affected by each of the concepts (10 %)

Answer 1

3.4

Using financial calculator

Input: FV= 1000

PV = -854.25

PMT = 5%*1000= 50

N = 10

Solve for I/Y as 7.08

The YTM is 7.08%. Since the bond is paying a coupon lower than the market interest rates exected, it is selling at a price below par.

3.5

Inflation refers to the loss of the value of money due to increasing prices of goods and services. Bondholders block their money in bonds and need to be compensated for the loss of money while they are not using the money. Hence they command a premium for their investment.

Default risk refers to the risk that the issuer of the bond may not repay the amount that has been invested with him. Again the bondholders need to be compensated for this risk by way of coupon amount. Higher the risk, higher should be the coupon rate.