Suppose you decide to invest in corporate bonds. Accordingly, you visit a bond store. You see...

Suppose you decide to invest in corporate bonds. Accordingly, you visit a bond store. You see 3 bonds on the shelf. One is priced at $1,015.53, another is priced to sell at $1,300.00, and a third is selling at a discounted amount of $876.06. All have a $1,000.00 face value, and carry equal risk. From your reading, and from class lecture, you know that you will be earning the same rate on your investment, regardless of which bond(s) you purchase. But you have a friend with you, who doesn't understand how you can possibly earn the same interest rate, due to the difference in purchase price. How will you explain this concept to him or her?

Solutions

Expert Solution

If the bond is of similar risk, then the require rate of the yield to maturity on the bonds are similar and if the price difference occurs then that difference is mainly due to the coupon payment or non-coupon payment. The important here to note is that bond can be premium bonds, discount bond or par value bond. When the coupon rate is 0, it is also called a zero coupon bond and that bond would be selling at discount, when the coupon rate is higher than the interest rate or YTM then the bond would be trading at a premium so in the above examples when the bonds are trading at a premium, that is their price is higher than the face value it is more likely because of the coupon rate which is higher than the interest rate so as long as the risk of the bond are similar, the expected return on bond would be same because they can be priced differently according to their expected future cash flows.

jeff jeffy answered 2 years ago

Next > < Previous

Related Solutions

2. Suppose that you have $250 to invest. a. You decide to store the $250 cash...

2. Suppose that you have $250 to invest. a. You decide to store the $250 cash under your mattress. If inflation is 3%, what will be the real value of that cash after one year under the mattress? b. If the nominal interest rate for a typical savings account is 1%, how much would the $250 be worth if you kept it in a savings account for 1 year? c. How much money did you lose by not depositing the...

Suppose you are an investor in bonds. Consider a corporate bond with a $100 par value,...

Suppose you are an investor in bonds. Consider a corporate bond with a $100 par value, a 5% coupon paid semi-annual coupon, and five years to maturity. The bond presently yields 3% annually. Suppose that interest rates rise shortly, and the yield on comparable bonds is now 4%. After observing this change, you call your broker Jane for a quote on the bond. Jane shows that the bond price is $105. You quickly realize that there is an arbitrage opportunity...

Suppose that you receive $1,000 as a gift and decide to invest it in a fund...

Suppose that you receive $1,000 as a gift and decide to invest it in a fund that pays a particular interest rate compounded quarterly. The rate is 6.56%. Determine how long it will take for this investment to grow to $7,500 by showing the value of the investment after each compounding period. Include columns showing the period number, the length of time that has passed.

When researching which corporate bonds to invest, you noted that some bonds were trading at a...

When researching which corporate bonds to invest, you noted that some bonds were trading at a premium (e.g. 4.7% coupon bonds issued by BSD Ltd was trading at 5% above its par value), whereas some were trading at a discount (e.g. 5.25% coupon bonds issued by API Ltd was trading 2% below its par value). Hypothesise four (4) reasons for your observations. (Approx 600 words) (About 150 words per hypothesise.)

Suppose you decide to open a digital photo printing store. You rent store space (signing a...

Suppose you decide to open a digital photo printing store. You rent store space (signing a one-year lease) and you take out a loan at a local bank and use the money to purchase 10 digital photo printing machines. Six months later a large chain opens a photo printing store two blocks away from yours. As a result, the revenue you receive from your photo printing store, while sufficient to cover the wages of your employees and the costs of...

You plan to invest $1,000 in a corporate bond fund or in a common stock fund....

You plan to invest $1,000 in a corporate bond fund or in a common stock fund. The table presents the annual return (per $1,000) of each of these investments under different economic conditions and the probability that each of these economic conditions will occur. Complete parts (a) through (d) below. Probability Economic_Condition Corporate_Bond_Fund Common_Stock_Fund 0.01 Extreme_recession -200 -980 0.09 Recession -70 -300 0.15 Stagnation 30 -100 0.35 Slow_growth 80 130 0.30 Moderate_growth 110 150 0.10 High_growth 120 350 Calculate the...

You plan to invest $1,000 in a corporate bond fund or in a common stock fund....

You plan to invest $1,000 in a corporate bond fund or in a common stock fund. The table presents the annual return (per $1,000) of each of these investments under different economic conditions and the probability that each of these economic conditions will occur. Probability Economic_Condition Corporate_Bond_Fund Common_Stock_Fund 0.01 Extreme_recession -250 -999 0.09 Recession -60 -300 0.20 Stagnation 30 -150 0.30 Slow_growth 80 70 0.35 Moderate_growth 120 200 0.05 High_growth 150 350 Calculate the expected return for the corporate bond...

would you like to invest in common stocks, preferred stocks, corporate bonds or Treasury bonds during...

would you like to invest in common stocks, preferred stocks, corporate bonds or Treasury bonds during COVID-19 pandemic? What will be the advantages and disadvantages of investing in each of these assets?

1. Dana intends to invest $62,000 in either a Treasury bond or a corporate bond. The...

1. Dana intends to invest $62,000 in either a Treasury bond or a corporate bond. The Treasury bond yields 5 percent before tax and the corporate bond yields 6 percent before tax. a-1. Assuming Dana’s federal marginal rate is 24 percent and her marginal state rate is 5 percent, which of the two options should she choose? Assume that Dana itemizes deductions. Corporate bond Treasury bond a-2. How much interest after-tax would Dana earn by investing in the corporate...

Dana intends to invest $30,000 in either a Treasury bond or a corporate bond. The Treasury...

Dana intends to invest $30,000 in either a Treasury bond or a corporate bond. The Treasury bond yields 5 percent before tax and the corporate bond yields 6 percent before tax. a-1. Assuming Dana’s federal marginal rate is 24 percent and her marginal state rate is 5 percent, which of the two options should she choose? Assume that Dana itemizes deductions. Corporate bond Treasury bond a-2. How much interest after-tax would Dana earn by investing in the corporate bond?...

Subjects