Question

3. Assume you have a 1-year investment horizon and are trying to choose among three
bonds. All have the same degree of default risk and mature in 10 years. The first is a zerocoupon
bond that pays $1,000 at maturity. The second has an 8% coupon rate and pays
the $80 coupon once per year. The third has a 10% coupon rate and pays the $100
coupon once per year.
a. If all three bonds are now priced to yield 8% to maturity, what are their prices?
b. If you expect their yields to maturity to be 8% at the beginning of next year, what
will their prices be then? What is your holding-period return on each bond?
c. Recalculate your answer to (b) under the assumption that you expect the yields to
maturity on each bond to be 7% at the beginning of next year.

Answer 1

Part A

a) Zero Coupon Bond On Financial Calculator type N = 10 I/Y = 8 PMT = 0 FV = 1000 Then press CPT and then PV Answer = 463.19

a) 8% coupon rate On Financial Calculator type N = 10 I/Y = 8 PMT = 80 FV = 1000 Then press CPT and then PV Answer = 1000

a) 10% coupon rate On Financial Calculator type N = 10 I/Y = 8 PMT = 100 FV = 1000 Then press CPT and then PV Answer = 1134.20

PART B

a) Zero Coupon Bond On Financial Calculator type N = 9 I/Y = 8 PMT = 0 FV = 1000 Then press CPT and then PV Answer = 500.24 HPR = [Income +(End Value – Initial Value)] / Initial Value = [0 +(500.24 – 463.19)] / 463.19 = 8%

a) 8% coupon rate On Financial Calculator type N = 9 I/Y = 8 PMT = 80 FV = 1000 Then press CPT and then PV Answer = 1000 HPR = [Income +(End Value – Initial Value)] / Initial Value = [80 +(1000 – 1000)] / 1000 = 8%

b) 10% coupon rate On Financial Calculator type N = 9 I/Y = 8 PMT = 100 FV = 1000 Then press CPT and then PV Answer = 1124.94 HPR = [Income +(End Value – Initial Value)] / Initial Value = [100 +(1124.94 – 1134.20)] / 1134.20 = 8%

PART C

c) Zero Coupon Bond On Financial Calculator type N = 9 I/Y = 7 PMT = 0 FV = 1000 Then press CPT and then PV Answer = 543.93 HPR = [Income +(End Value – Initial Value)] / Initial Value = [0 +(543.93 – 463.19)] / 463.19 = 17.43%

c) 8% coupon rate On Financial Calculator type N = 9 I/Y = 7 PMT = 80 FV = 1000 Then press CPT and then PV Answer = 1065.15 HPR = [Income +(End Value – Initial Value)] / Initial Value = [80 +(1065.15 – 1000)] / 1000 = 14.51%

c) 10% coupon rate On Financial Calculator type N = 9 I/Y = 7 PMT = 100 FV = 1000 Then press CPT and then PV Answer = 1195.46 HPR = [Income +(End Value – Initial Value)] / Initial Value = [100 +(1195.46 – 1134.20)] / 1134.20 = 14.22%