Question

Today, it’s January the 1^st, 2020. A New Year Means New Opportunities to make money investing in bonds.

You are the investment manager of a Bond Fund.

You have the following three bonds in portfolio that needs re-evaluation:

1. Bond 1 ABC
2. Bond 2 DEF
3. Bond 3 XYZ

For more information about the three bonds, please take a look at the bottom of this page.

You expect that market interest rates will remain stable for the next 5 years at 3%, but after year 5, you expect the yield curve to go up = interest rates will go to 4% for year 6-10.  

1. What is the Fair Value of Bond 2? Show calculations

Bond 2 DEF 2019-2024 (Jan 1 issued, paid back Dec 31 2024)

Coupon rate 4%, Annual Coupons

Current Price $1.023

Par Value $1.000

Answer 1

	FAIR VALUE OF THE BOND =PRESENT VALUE OF FUTURE CASH FLOWS
	Annual Coupon =4%*$1000	$40
	Payment at maturity	$1,000
	Total Payment in Year6 (December 31,2024)	$1,040	(1000+40)
	Value of Payment of $1040 at end of year 5(Decem 31,2023)	$1,000	(1040/(1+0.04)		Discount rate=4%
	Coupon Payment at end of December , 2023	$40
		N		CF	PV=CF/(1.03^N)
		Year	Date	Cash Flow	Present Value
	Coupon Payment at end of December	1	Dec31,2019	$40	$38.83
	Coupon Payment at end of December	2	Dec31,2020	$40	$37.70
	Coupon Payment at end of December	3	Dec31,2021	$40	$36.61
	Coupon Payment at end of December	4	Dec31,2022	$40	$35.54
	Coupon Payment at end of December	5	Dec31,2023	$40	$34.50
	Value of Payment of $1040 at end of year 5(Decem 31,2023)	5	Dec31,2023	$1,000	$862.61
				SUM	$1,045.80
	Fair Value of Bond 2	$1,045.80