Question

Q2: Bond Valuation

Consider the following bonds issued by Romana Co to raise $50m. The two bonds have a 10-year maturity and face value of $1000.

• Bond A is a coupon- paying bond with coupon rate of 6% paid annually
• Bond B is a zero- coupon bond

Required:

1. Estimate the price of bond A & B at 2% yield to maturity.
2. If yield to maturity rise from 2 to 2.5 %. Re-estimate the price of bond A & B at 2.5%.
3. As an investor which bond would you prefer and why?

Answer 1

(C) as a rational Investor and as a finance person I would be indifferent between both the bond because both will provide the same yield at the end. But people may choose different bond for different requirements of I am retired person i would be required the coupon payment that means bond A because retired person dies not have any other income if I would be working individual then I would have choosen zero coupon bond. As I would be attracted by capital gain. But in reality both are having the same impact. But when we look from the angle of tax I would prefer coupon bond because the capital gain arise at the last year Increase the tax liability in to zero coupon bond and tax would be chargeable at higher rate because income is really high. While in coupon bond our income is low our income will be taxable at lower rate and at the end of the period we will have capital loss that means at that time we can get tax benefits. So I would prefer coupon bond A