In: Finance
On March 31st, 2020, you take delivery of a $100,000 T-bond that matures on October 31st, 2030. The coupon rate on the T-bond is 4.20% and the current yield to maturity on the bond is 3.80%. The last coupon payment occurred on October 31st, 2019 and the next coupon payment occurs on April 30th, 2020. Calculate the clean and dirty prices of this transaction.
In the given question following information is given:
Now let us first understand the meaning of clean and dirty prices. Dirty price of the transaction is the present value of all future cash flows including accrued interest in the near future and clean price of the transaction is the present value of all future cash flows that does not include any accrued interest in the near future. Accrued interest is the interest outstanding to be received from the bond at the coupon rate.
Now, the present values of future cash flows would be calculated using semi-annual yield to maturity rate i.e. 1.90% for 21 semiannual periods from April 30th, 2020 to October 31st, 2030 with semiannual interest of $2,100 calculated as below:
Semiannual interest = Interest * 6/12
Semiannual interest = ($100,000 * 4.20%) * 6/12
Semiannual interest = $4,200 * 6/12
Semiannual interest = $2,100
Statement showing Present Value of Bond
Semi annualy period | Particulars | Amount (A) | Discounted Factor @ 1.90% (B) |
Present Value (A * B) |
1 | Semi annual interest | 2,100 | 0.9814 | 2,061 |
2 to 21 | Semi annual interest | 2,100 | 16.2025 | 34,025 |
21 | Maturity amout of Bond | 100,000 | 0.6735 | 67,350 |
Total Present Value of Bond | 103,436 |
Hence,
Clean price of the bond will be the present value of bond i.e. $103,436
Dirty price of the bond = Present value of bond + Interest accrued for one month
Dirty price of the bond = $103,436 + ($100,000 * 4.20% * 1/12)
Dirty price of the bond = $103,436 + $350
Dirty price of the bond = $103,786