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An investor considers the purchase of a 2-year bond with a 5% coupon rate, with interest...

An investor considers the purchase of a 2-year bond with a 5% coupon rate, with interest paid annually and par of 100. The spot rates observed in the market today are as follows: 1-yr spot is 3%, the 2-yr spot is 4% and the 3-yr spot is 5%. The clean price of the bond is closest to: a. 101.93. b. 102.85. c. 105.81. d. 102.36. e. 103.10.

Solutions

Expert Solution

Bond Price:
It refers to the sum of the present values of all likely coupon payments plus the present value of the par value at maturity. There is inverse relation between Bond price and YTM ( Discount rate ) and Direct relation between Cash flow ( Coupon/ maturity Value ) and bond Price.

Price of Bond = PV of CFs from it.

Year Cash Flow PVF/ PVAF @4 % Disc CF
1 - 2 $        5.00                           1.8860 $         9.43
2 $    100.00                           0.9250 $      92.50
Bond Price $    101.93

As Coupon Payments are paid periodically with regular intervals, PVAF is used.
Maturity Value is single payment. Hence PVF is used.

What is PVAF & PVF ???
PVAF = Sum [ PVF(r%, n) ]
PVF = 1 / ( 1 + r)^n
Where r is int rate per Anum
Where n is No. of Years

How to Calculate PVAF using Excel ???
+PV(Rate,NPER,-1)
Rate = Disc rate
Nper = No. of Periods

OPtion A is correct.

jeff jeffy answered 2 years ago
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