Question

You have an 3.5% coupon Verizon corporate bond making annual coupon payments, there are three years until maturity and the yield to maturity is 8%

a)Calculate the bond's price

B) Calculate duration

c) If you can choose from the bond above and a new bond with a duration 3.0 which would you prefer if you expect a yield increase of 0.25%

Answer 1

a) Bond Price =Present Value of Future Cash Flows

Assuming Face Value

Cash Flow in Year 1=Coupon Payment =$1000*3.5%=$35

Cash Flow in Year 2=$35

Cash Flow in Yeare 3=$35+$1000(Payment at redemption)=$1035

Yield to maturity =8%=0.08

Present Value of Future Cash Flows=(35/(1+0.08))+(35/((1+0.08)^2))+(1035/((1+0.08)^3))

Present Value of Future Cash Flows=(35/1.08)+(35/(1.08^2))+(1035/(1.08^3))=884.03

BOND PRICE=$884.03

b) BOND DURATION:

Bond Duration = Present value of (cash flows multiplied by length of time to receipt) / (the  current market value)
	N	CF	A=CF/(1.08^N)	B=N*CF	C=B/(1.08^N)
	Annual period	Cash Flow	Present Value at 8%	Year*Cash Flow	Present Value at 8%
	1	$35	$32.41	$35	$32.41
	2	$35	$30.01	$70	$60.01
	3	$1,035	$821.62	$3,105	$2,464.85
		SUM	$884.03		$2,557.27
Current Market Price	$884.03
Bond Duration = 2557.27/884.03	2.89

c) If Yield increases, the Bond Price will decrease

If yield increases by 0.25%, Bond Price of this bond witll decrease by (2.89*0.25)=0.72%

New Bond with duration 3 years , the price will decrease by (3*0.25)=0.75%

Hence, the old bond should be preferred