Fixed Income

pooja923
Good Student
Posts: 25
Joined: Fri Mar 11, 2016 11:38 am

Fixed Income

Postby pooja923 » Mon May 16, 2016 2:11 pm

Consider a bond that pays an annual coupon of 5% and that has three years remaining until maturity. Assume the term structure of interest rates is flat at 6%. If the term structure of interest rates does not change over the next twelve-month interval, the bond's price change (as a percentage of par) will be closest to:
1. 0.84.
2. -0.84.
3. 0.00.

Old Price =5/1.06 + 5/1.06 + 105/1.06 = 97.33
On what basis should I calculate the New price?

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Re: Fixed Income

Postby edupristine » Tue May 17, 2016 8:33 am

Hi Pooja
Correct answer is 1. (0.84)
as you calculated the Old price
FV= 100, PMT= 5, n=3, i= 6

in the calculation of New price n=2
so the answer is

Bond Price Change = New Price − Old Price = (5/1.06 + 105/1.062) − (5/1.06 + 5/1.062 + 105/1.063) = 98.17 − 97.33 = 0.84

pooja923
Good Student
Posts: 25
Joined: Fri Mar 11, 2016 11:38 am

Re: Fixed Income

Postby pooja923 » Tue May 24, 2016 6:04 pm

Three bonds are identical in credit quality and all other respects except the following:
    Bond X: Noncallable, accelerated sinking fund.
    Bond Y: Callable, accelerated sinking fund.
    Bond Z: Noncallable, no sinking fund

The correct order for these three bonds, from highest yield to lowest yield, is:
1. Bond Y; Bond Z; Bond X.
2. Bond Y; Bond X; Bond Z.
3. Bond X; Bond Z; Bond Y.

The correct option in 2. But Bond X is less risky compared to Bond Z because of the early retirement of the principal amount so the yield of Bond Z (more risky) should be higher.

edupristine
Finance Junkie
Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Re: Fixed Income

Postby edupristine » Wed May 25, 2016 7:10 am

Hi Pooja
Bond Z has no provisions for early retirement (which are unfavorable for the bondholder, other things equal), so it should yield the lowest. Bond X is noncallable, but allows the issuer to redeem principal through an accelerated sinking fund. Bond Y has an accelerated sinking fund and is callable, giving the issuer the most flexibility, and therefore requiring the highest yield.


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