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The following is the data on $ 1,000 par value bonds issued by PALMA CO, ZICO CO

ID: 2771283 • Letter: T

Question

The following is the data on $ 1,000 par value bonds issued by PALMA CO, ZICO CO & REX CO. at the end of 2005. Assume that you are thinking of buying these bonds as of January 2006. Answer the following questions for each of the bonds.

(a) Calculate the values of the bonds if your required rates of returns are as follows: PALMA. Co 6%, ZICO CO 9% & REX 8%

PALMA CO

ZICO CO

REX CO

Coupon Interest Rate

7.8%

7.5%

7.975%

Years to Maturity

10

17

4

(b) In December 2005, the bonds were selling for the followings amounts:

PALMA CO

$ 1,030.

ZICO CO

$    973

REX CO

$ 1,035

What were the expected rates of return for each bond?

(c) How would the values of the bonds change if:

     (i) Your required rate of return increases by 3% points?                

     (ii) Your required rate of return decreases by 3% points?  

(d) Explain the implications of your answers in question (b) and (c) as they relate to interest rate risk, premium bonds and discount bonds.     (2 marks)

(e) Compute the duration for each of the bonds. Interpret your results.    (10 marks)

(f) What are some of the things you can conclude from the above computations?  

(3 marks)

(g) Should you buy the bonds? Explain.

PALMA CO

ZICO CO

REX CO

Coupon Interest Rate

7.8%

7.5%

7.975%

Years to Maturity

10

17

4

Explanation / Answer

Answer (b)

Answer (c )

Answer(D)

When the require rate of return increase, current market price decreases, and when it decreases current market price increases.

Bond Price B0= (Annual Interest*(PVIFA RR,n))+(Maturity Value*(PVIF RR,n)) Particulars Palma Co Zico Co Rex Co Face Value 1000 1000 1000 Coupon Rate 7.80% 7.50% 7.975% Interest 78 75 79.75 Years to maturity (n) 10 17 4 Required Return (RR) 6.00% 9% 8% Answer (a) Bond Price B0= (Annual Interest*(PVIFA RR,n))+(Maturity Value*(PVIF RR,n)) Palma Bond Price B0= (78*(PVIFA 6%,10))+(1000*(PVIF 6%,10)) (78*7.36)+(1000*0.5584) 1132.48 Zico Bond Price B0= (75*(PVIFA 9%,17))+(1000*(PVIF 9%,17) (75*8.5436)+(1000*0.2311) 871.87 Rex Bond Price B0= (79.75*(PVIFA 8%,4))+(1000*(PVIF 8%,4)) (79.75*3.312)+(1000*0.7350) 999.132