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Question 2 (25 marks/Bond Valuation)

David Palmer identified the following bonds forinvestment:

1) Bond A: A $1 million par, 10% annual coupon bond, whichwill mature on July 1, 2025.

2) Bond B: A $1 million par, 14% semi-annual coupon bond(interest will be paid on January 1 and July 1 each year), whichwill mature on July 1, 2031.

3) Bond C: A $1 million par, 10% quarterly coupon bond(interest will be paid on January 1, April 1, July 1, and October 1each year), which will mature on July 1, 2026.

The three bonds were issued on July 1, 2011.

(Each Part is Independent)

(a) If Bond B is issued at face value and both Bond B and BondA are having the same yield to maturity (EAR), calculate the marketprice of Bond A on July 1, 2011. [Note: Full mark would only begiven to correct answer of which the values of those variables notprovided in the question directly are derived.]

(b) David purchased the Bond C on January 1, 2014 when Bond Cwas priced to have a yield to maturity (EAR) of 10.3812891%. Davidsubsequently sold Bond C on January 1, 2016 when it was priced tohave a yield to maturity (EAR) of 12.550881%. Assume all interestsreceived were reinvested to earn a rate of return of 3% per quarter(from another investment account), calculate the current yield,capital gain yield and the 2-year total rate of return (HPY) oninvestment for David on January 1, 2016. [Hint: Be careful with howmany rounds of coupons has David received during the holding periodand thus how much interests (coupons and reinvestment of coupons)he has earned in total during the 2-year holding period.]

(c) David purchased Bond B on a coupon payment day. Bond B ispriced to have a yield to maturity (EAR) of 12.36% and its marketvalue is $1,101,058.953 on the date of purchase. Find the remaininglife until maturity (in terms of 6-month period or year) of Bond B.

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