A company must pay $5000 at the end of each year for 4 years. Given the followin

Question

A company must pay $5000 at the end of each year for 4 years. Given the following four bonds construct a dedicated bond portfolio that eliminates interest rate risk. Determine the face value (to the cent) of each of the following bonds purchased.

BOND A: 1-year bond with 4% annual coupon, redeemable at 103%

ANS

BOND B: 2-year zero coupon bond, redeemable at par.

ANS

BOND C: 3-year bond with 5% annual coupons, redeemable at par

ANS

BOND D: 4-year bond with 5.5% annual coupons, redeemable at par

ANS

Explanation / Answer

BOND A: 1-year bond with 4% annual coupon, redeemable at 103%

ANS Face Value= (5000 - 260.66 - 225.68)/(103%+4%)

Face Value= $ 4218.37

BOND B: 2-year zero coupon bond, redeemable at par.

ANS Face Value= (5000 - 260.66 - 225.68)

Face Value= 4513.66

BOND C: 3-year bond with 5% annual coupons, redeemable at par

ANS Face Value= (5000-260.66)/(1+5%)

Face Value= $ 4513.66

BOND D: 4-year bond with 5.5% annual coupons, redeemable at par

ANS Face Value = 5000/(1+5.5%)

Face Value = 4739.34

Note

Annual Coupon on Bond D = 4739.34*5.5% = 260.66

Annual Coupon on Bond C = 4513.66*5% = 225.68

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.