Question

Which security should sell at a greater price?

a. A 5-year Treasury bond with a 7.00% coupon rate versus a 5-year Treasury bond with a 3.00% coupon.

b. A 10-year Treasury bond with a 5% coupon bond versus a 20-year Treasury bond with a 5% coupon.

c. A 10-year Treasury bond with a 5% coupon bond versus a 10-year BBB corporate bond with a 5% coupon.

Answer 1

a.

The term for both bonds is same, however, the coupon payment receivable on the first bond is higher than coupon payment receivable on the second bond. Since coupon payments are higher in the first bond, their present value will also be higher than present value of coupon payments of the second bond provided discount factor applicable on both bonds is same.

Hence, The first bond should be sold at greater price.

b.

The term for the first bond is 10 years which includes 10 coupon payments. The second bond has a 20 year term that means 20 coupon payments. Since the second bond consists of a higher number of payments, the present value of all 20 coupon payments will be higher than present value of all 10 coupon payments (mentioned for the first bond).

Hence, The second bond should be sold at greater price.

c.

The term and coupon payment for both bonds are same.

Sometimes, an investor finds two different bonds having same maturity period and coupon rate but having different risks. In such cases, the investor will go for the bond which has low risk. In order to purchase the bond with lower risk, the investor is ready to pay a little higher price.

The second bond is BBB rated bond which means it is safe to invest in the bond.

Hence, BBB corporate bonds should be sold at greater price.