Question

Assume you have a one-year investment horizon and are trying to choose among three bonds. All have the same degree of default risk and mature in 10 years. The first is a zero-coupon bond that pays $1,000 at maturity. The second has an 8.9% coupon rate and pays the $89 coupon once per year. The third has a 10.9% coupon rate and pays the $109 coupon once per year.

a.	If all three bonds are now priced to yield 8.9% to maturity, what are their prices? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Zero	8.9% Coupon	10.9% Coupon
Current prices	$	$	$

b-1.	If you expect their yields to maturity to be 8.9% at the beginning of next year, what will their prices be then? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Zero	8.9% Coupon	10.9% Coupon
Price one year from now	$	$	$

b-2.	What is your rate of return on each bond during the one-year holding period? (Do not round intermediate calculations.Round your answers to 2 decimal places.)

	Zero	8.9% Coupon	10.9% Coupon
Rate of return	%	%	%

Answer 1

		Price of Bond =Present Value of future cash flows
		First Bond :Zerocoupon with maturity payment of $1000
	Rate	Yield to maturity	8.90%
	Nper	Number of years to maturity	10
	Fv	Payment at maturity	$1,000
	PV	Current Price	$426.31	(Using PV function of excelwith Rate=8.9%, Nper=10,Fv=-1000)
		Second Bond :8.9% coupon
	Rate	Yield to maturity	8.90%
	Nper	Number of years to maturity	10
	Pmt	Annual Coupon Payment	$89
	Fv	Payment at maturity=Face value	$1,000	(89/8.9%)
	PV	Current Price	$1,000	(Using PV function of excelwith Rate=8.9%, Nper=10,Pmt=-89,Fv=-1000)
		Third Bond :10.9% coupon
	Rate	Yield to maturity	8.90%
	Nper	Number of years to maturity	10
	Pmt	Annual Coupon Payment	$109
	Fv	Payment at maturity=Face value	$1,000	(109/10.9%)
	PV	Current Price	$1,129	(Using PV function of excelwith Rate=8.9%, Nper=10,Pmt=-109,Fv=-1000)
			Zero	8.9% Coupon	10.9% Coupon
		Current prices	$426.31	$1,000	$1,129
	b	Yield to maturity 8.9% at the beginning of next year
		Number of Years to maturity fromnext year=9
		First Bond :Zerocoupon with maturity payment of $1000
	Rate	Yield to maturity	8.90%
	Nper	Number of years to maturity	9
	Fv	Payment at maturity	$1,000
	PV	Price One year FromNow	$464.25	(Using PV function of excelwith Rate=8.9%, Nper=9,Fv=-1000)
		Second Bond :8.9% coupon
	Rate	Yield to maturity	8.90%
	Nper	Number of years to maturity	9
	Pmt	Annual Coupon Payment	$89
	Fv	Payment at maturity=Face value	$1,000	(89/8.9%)
	PV	Price One year FromNow	$1,000	(Using PV function of excelwith Rate=8.9%, Nper=9,Pmt=-89,Fv=-1000)
		Third Bond :10.9% coupon
	Rate	Yield to maturity	8.90%
	Nper	Number of years to maturity	9
	Pmt	Annual Coupon Payment	$109
	Fv	Payment at maturity=Face value	$1,000	(109/10.9%)
	PV	Price One year FromNow	$1,120	(Using PV function of excelwith Rate=8.9%, Nper=9,Pmt=-109,Fv=-1000)
			Zero	8.9% Coupon	10.9% Coupon
		Price One year FromNow	$464.25	$1,000	$1,120
	c	Rate of Return on One year Holding
		Rate of return on Zero Coupon Bond	8.90%	(464.25-426.31)/426.31
		Rate of return on 8.9% Bond	8.90%	((1000-1000)+89)/1000
		Rate of return on 10.9% Bond	8.86%	((1120-1129)+109)/1129
			Zero	8.9% Coupon	10.9% Coupon
		Rate of return	8.90%	8.90%	8.86%