Question

market rate has hit 5.5%.

Suppose you are holding a series of bonds as part of a total portfolio.  

Changes in interest rate conditions have resulted in depositors wanting to withdraw funds.

This will necessitate selecting which of the following to sell for current cash.

Rank order them, explain why.

Bond #1:

Is starting year 3 of its 8 year life to maturity. It is a 5% YTM with a 4% annual coupon.Its value at maturity will be 1,000,000.

We are getting 320,000 in coupons over the 8 years, and the 1,000,000 at the end.

Bond #2:

Is starting year 4 of its 10 year maturity. It is a 4.5% YTM with a 2% annual coupon. Its value at maturity will be 1,000,000.

Bond #3:

Is starting year 2 of its 8 year maturity. It is a 4.75% YTM with zero coupon.Its value at maturity will be 1,000,000. We are getting 1,000,000 at the end.

Bond #4:

Was purchased this morning prior to the announcement regarding interest rates. It’s a 5 year bond with 5% YTM with a 1% coupon. Its value at maturity will be 1,000,000.

Answer 1

Past Situation	Bond # 1	Bond # 2	Bond # 3	Bond # 4
Face Value (FV)	$1,000,000.00	$1,000,000.00	$1,000,000.00	$1,000,000.00
Annual Coupon Rate	4.00%	2.00%	0.00%	1.00%
Annual Coupon Payment = PMT	$40,000.00	$20,000.00	$0.00	$10,000.00
YTM = Rate	5.00%	4.50%	4.75%	5.00%
Nper	8	10	8	5
Current Price = PV(rate,nper,-PMT,-FV)	$935,367.87	$802,182.05	$689,870.77	$826,820.93
Today's Situation
	Bond # 1	Bond # 2	Bond # 3	Bond # 4
Face Value (FV)	$1,000,000.00	$1,000,000.00	$1,000,000.00	$1,000,000.00
Annual Coupon Rate	4.00%	2.00%	0.00%	1.00%
Annual Coupon Payment = PMT	$40,000.00	$20,000.00	$0.00	$10,000.00
YTM = Rate	5.50%	5.50%	5.50%	5.50%
Nper	6	7	7	5
Current Price = PV(rate,nper,-PMT,-FV)	$925,067.05	$801,096.15	$687,436.81	$807,837.20
Difference = Loss Incurred	$10,300.83	$1,085.89	$2,433.97	$18,983.73
Ranking to Sell	III	I	II	IV
Reason
1) Loss on Principal -
2) Loss of Interest
3)Capital Gains Tax