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In chapter 6, Bond Valuations techniques are introduced A bond is a debt security, like ‘IOU.’...

In chapter 6, Bond Valuations techniques are introduced

  • A bond is a debt security, like ‘IOU.’
  • The bond issuers borrow from the Bond Investors.
  • The issuers agree to repay the principal amount of the loan on the maturity date.
  • Thus, a bond represents loans from the holder to the issuer.

In this assignment, you are to discuss the following with numerical examples:

  1. What are the features of a zero-coupon bond?
  2. Explain the concept of Zero Coupon bond yields and its pricing behavior
  3. What are the features of a coupon bonds?

Solutions

Expert Solution

Answer(1):

Features of zero-coupon bond- This is a debt security that is issued at deep discount and makes no coupon payments that is the reason, its name is Zero coupon bond. Zero coupon bonds are riskier bonds, they have the default risk, their rating is not good that is the reason company has to issue zero coupon bond at deep discount so when bond holder redeems the bond at the face value in the maturity, he gets profit.

Value of zero coupon bond is calculated with the help of present value formula.

Formula: Value of zero coupon bond (PV) = FV / (1+r)n

Where FV is Face/Maturity value, r is rate of interest and n is number of years to maturity.

Numerical example: A 5 year zero coupon bond has the Face value of $1000, Rate on the similar bond in the market is 8%. Calculate value of the zero coupon bond?

SOLUTION: Formula- PV = FV / (1+r)n

PV: 1000 / (1+.08)5 = 680.58

Answer(2):

Zero Coupon bond yields- Zero coupon bond does not pay coupons that is the reason, its yield calculation differs from the coupon paying bond's yield calculation.

Formula: YTM = (FV/PV)(1/n) - 1

Numerical Example: YTM = (1000/925)(1/2) - 1

YTM = 3.98%

Price of zero coupon bond fluctuates more than the coupon bond.

Answer(3): Features of a coupon bond- Are as following:

  • A coupon bond is the bond that makes coupon payment semiannually.
  • It is also called Bearer bond.
  • Coupon bond is physical in nature. It is kept in certificate form.
  • It does not mention the name of the issuer on the face of the bond.
  • Coupon rate is calculated by taking the sum of all the coupons paid per year, divided by the bond's face value.

jeff jeffy answered 1 year ago
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