LE 2 -- Bond Concepts(1).docx

# LE 2 -- Bond Concepts(1).docx - Principles of Investments...

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Principles of Investments Learning Exercise 2 B OND C ONCEPTS N. Gershun P ART 1: T HEORETICAL P ROBLEMS 1. Suppose that the price of discount (zero coupon) bonds maturing in years 1, 2, 3, 4, and 5 are given (respectively) by Price Time to Maturity 940 1 870 2 800 3 715 4 630 5 Consider the following risk-free investments. Which is best? T=0 1 2 3 4 5 Investment A -40 20 15 10 5 1 Investment B -10 1 5 10 15 20 940(1 + r 1 )=1000, or discount factor one is 1 1 + r 1 = 940 1000 = 0.94 870(1+r 2 ) 2 =1000, or discount factor two is 1 ( 1 + r 2 ) 2 = 870 1000 = 0.87 800(1+r 3 ) 3 =1000, or discount factor three is 1 ( 1 + r 3 ) 3 = 800 1000 = 0.8 715(1+r 4 ) 4 =1000, or discount factor four is 1 ( 1 + r 4 ) 4 = 715 1000 = 0.715 630(1+r 5 ) 5 =1000, or discount factor five is 1 ( 1 + r 5 ) 5 = 630 1000 = 0.63 A: NPV= -40+20(0.94)+15(0.87)+10(0.8)+15(0.715)+1(0.63)=\$4.05

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B: NPV= -10+1(0.94)+5(0.87)+10(0.8)+15(0.715)+20(0.63)=\$26.61 Project B is the best choice to because project B will increase share price the most because it has a higher NPV. 2. Three zero coupon risk-free discount bonds of one, two and three year term to maturity are selling for, respectively, \$950, \$890 and \$800. What would be the selling price today of a 10% coupon bond of 3 year maturity (maturity value \$1,000)? Three discount bonds give the following discount factors: 950 = 1000 1 + r 1 therefore 1 1 + r 1 = 950 1000 = 0.95 890 = 1000 ( 1 + r 2 ) 2 therefore 1 ( 1 + r 2 ) 2 = 890 1000 = 0.89 800 = 1000 ( 1 + r 3 ) 3 therefore 1 ( 1 + r 3 ) 3 = 800 1000 = 0.8 PRICE(10%BOND)=PV(CASH FLOWS) CASH FLOWS : t = 0 1 2 3 100
• Fall '17
• musab kurnaz
• YTM, Bond concepts

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