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Assume you have a one-year investment horizon and are trying to choose among three bonds. All...

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Finance

Assume you have a one-year investment horizon and are trying tochoose among three bonds. All have the same degree of default riskand mature in 10 years. The first is a zero-coupon bond that pays$1,000 at maturity. The second has an 8.6% coupon rate and pays the$86 coupon once per year. The third has a 10.6% coupon rate andpays the $106 coupon once per year.

a.

If all three bonds are now priced to yield 8.6% to maturity,what are their prices? (Do not roundintermediate calculations. Round your answers to 2decimal places.)

Zero8.6% Coupon10.6% Coupon
  Current prices$        $    $     
b-1.

If you expect their yields to maturity to be 8.6% at thebeginning of next year, what will their prices be then? (Donot round intermediate calculations. Round youranswers to 2 decimal places.)

Zero8.6% Coupon10.6% Coupon
  Price one year from now$     $     $     
b-2.

What is your rate of return on each bond during the one-yearholding period? (Do not round intermediatecalculations.Round your answers to 2 decimalplaces.)

Zero8.6% Coupon10.6% Coupon
  Rate of return%      %      %      

Answer & Explanation Solved by verified expert
3.6 Ratings (594 Votes)

a] Current price of zero coupon bond = 1000/1.086^10 =   $             438.23
Current price of the second bond = $          1,000.00
[As the coupon rate and the market
rate are tge same the price of the
second bond will be equal to the
face value]
Current price of the third bond = 1000/1.086^10+106*(1.086^10-1)/(0.086*1.086^10) = $          1,130.64
b-1] Price of the zero coupon bond = 1000/1.086^9 = $             475.92
Price of the second bond = $          1,000.00
Current price of the third bond = 1000/1.086^9+106*(1.086^9-1)/(0.086*1.086^9) = $          1,121.88
b-2] Rate of return of zero coupon bond = 475.92/438.23-1 = 8.60%
Rate of return of the second bond = (86+1000-1000)/1000 = 8.60%
Rate of return of the second bond = (106+1121.88-1130.64)/1130.64 = 8.60%
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