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 8.6% coupon rate and pays the $86 coupon once per year. The third has a 10.6% coupon rate and pays 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 round intermediate calculations. Round your answers to 2 decimal places.)

	Zero	8.6% Coupon	10.6% Coupon
Current prices	$	$	$

b-1.	If you expect their yields to maturity to be 8.6% 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	8.6% Coupon	10.6% 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	8.6% Coupon	10.6% Coupon
Rate of return	%	%	%

Answer 1

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%