Problem 4 - Bonds You recently inherited from your late uncle a US government bo
ID: 2484591 • Letter: P
Question
Problem 4 - Bonds
You recently inherited from your late uncle a US government bond that matures December 31, 2025. The bond has a face value of 20,000 USD, which is equal to its redemption value. It pays an annual interest of 8%, payable semi-annually (i.e. as 4%) on June 30 and December 31 of each year. Answer the following question by performing your calculations both analytically and by using the relevant Excel functions.
a) If you wish to earn a 5% semi-annual return on your bond investment, what is the value of this bond to you on July 1, 2016?
b) If the bond trades for 17,988 USD in the market on July 1, 2016, would you sell it? Shortly explain why.
c) In reference to part (b) above, if there was a 3% transaction fee you have to pay to the tradinghouse, would you sell it, or buy more of the bond?
d) If bond yield rates (per semi-annum) in the market are currently around 4.78%, what market price does this predict for your bond on July 1, 2016?
e)If the bond trades for 17,988 USD in the market on July 1, 2016, what is the implied bond-yield rate?
Explanation / Answer
a Bond value Price 17583 Working Bond Price formula C*[1-[1/(1+i)n]/i+M/(1+i)n Bond Value 800*(1-1/(1+0.05)^19)/0.05+20000/(1+0.05)^19 = 17,583 C= (20000*8%)/2 = 800 M= 20,000 Half yearly interest rate 5% n 19 b Yes it shoud be sale at 17988 because its selling value as on 01 July is 17583 c If transaction fees 3% Sales price 17988 Transaction fees 540 Net Value 17,448 So in this case Bond should not be sale because it's less selling price of 17583 d If market rate is 4.78% Bond Value 800*(1-1/(1+0.0478)^19)/0.0478+20000/(1+0.0478)^19 = 18,080
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