Question

QUESTION 2 – Valuing Bonds – 20 marks

1. Treasury bills

1. LICI tendered for $5m of 180 days Treasury Bills (T-Bills) at a yield of 5.0 percent at 9.30am today. At 2pm LICI was informed that their tender of $5m was successful and payment needs to be made to the Reserve Bank by 3.30pm today.

How much will LICI pay to the Reserve Bank?

2. After 120 days of holding on to the T-Bills, i.e. 60 days left to maturity, LICI is contemplating selling the $5m T-Bills to the Reserve Bank. According to the current yield curve, the T-Bill rates are as follows:

• 180 days are yielding 4.95 percent
• 120 days are yielding 4.90 percent
• 90 days are yielding 4.87 percent
• 60 days are yielding 4.85 percent
• 30 days are yielding 4.80 percent

How much can LICI sell the $5m T-bills for after holding it for 120 days?

(b)      Bonds

Semi Leba, a retiree, invested part of his FNPF funds in government bonds. Semi holds $50,000 worth of Viti Bonds. The coupon rate of this Viti Bond is 5%. This bond pays coupon every quarter. The bond will mature in exactly 5 years from today. The current market rate for 5-year treasury bonds is 4.5%.

QUESTIONS

1. What is the value of this bond today?
2. Is this a premium or discount bond? Why?
3. What should Semi do with his bond? Give reasons for your recommendation.

Answer 1

a]

Amount paid by LICI to Reserve Bank =

$5 million / (1 + (0.05 * (180 / 360))) = $4,878,048.78

After 120 days, there are 60 days remaining to maturity. LICI can sell the bonds for :

$5 million / (1 + (0.0485 * (60 / 360))) = $4,959,907.42

b]

Value of bond today is calculated using the PV function in Excel with these inputs :

rate = 4.5% / 4 - converting the annual market rate into a quarterly rate

nper = 5 * 4 - 5 years to maturity with 4 quarterly coupon payments each year

pmt = 50,000 * 5% / 4 - each coupon payment is face value * coupon rate / number of quarters per year

fv = 50,0 - face value of bond receivable on maturity

PV is calculated to be $51,113.78

The value of the bond today is $51,113.78

This is a premium bond as its value is higher than its face value of $50,000

Semi can hold on to the bond as it pays a quarterly coupon payment. It is a safe investment as it is a government bond. The premium or discount of the bond is irrelevant.