Question

Bond X is a premium bond making semiannual payments. The bond pays a coupon rate of 9 percent, has a YTM of 7 percent, and has 13 years to maturity. Bond Y is a discount bond making semiannual payments. This bond pays a coupon rate of 7 percent, has a YTM of 9 percent, and also has 13 years to maturity. The bonds have a $1,000 par value.

What is the price of each bond today? If interest rates remain unchanged, what do you expect the price of these bonds to be one year from now? In three years? In eight years? In 12 years? In 13 years?

Answer 1

Bond X

current market price:

PV of face value = $1,000 / (1 + 3.5%)²⁶ = $

PV of coupon payments = $45 x 16.89035 (PV annuity factor, 3.5%, 26 periods) = $760.07

current market price = $408.84 + $760.07 = $1,168.91

price in 1 year:

PV of face value = $1,000 / (1 + 3.5%)²⁴ = $437.96

PV of coupon payments = $45 x 16.05837 (PV annuity factor, 3.5%, 24 periods) = $722.63

market price = $437.96 + $722.63 = $1,160.59

price in 3 years:

PV of face value = $1,000 / (1 + 3.5%)²⁰ = $502.57

PV of coupon payments = $45 x 14.2124 (PV annuity factor, 3.5%, 20 periods) = $639.56

market price = $502.57+ $639.56 = $1,142.13

price in 8 years:

PV of face value = $1,000 / (1 + 3.5%)¹⁰ = $708.92

PV of coupon payments = $45 x 8.31661 (PV annuity factor, 3.5%, 10 periods) = $374.25

market price = $708.92 + $374.25 = $1,083.17

price in 12 years:

PV of face value = $1,000 / (1 + 3.5%)² = $933.51

PV of coupon payments = $45 x 1.89969 (PV annuity factor, 3.5%, 2 periods) = $85.49

market price = $933.51 + $85.49 = $1,019

price in 13 years:

market price = $1,000 + $45 = $1,045

Bond Y

current market price:

PV of face value = $1,000 / (1 + 4.5%)²⁶ = $318.40

PV of coupon payments = $35 x 15.14661 (PV annuity factor, 4.5%, 26 periods) = $530.13

current market price = $318.40 + $530.13 = $847.53

price in 1 year:

PV of face value = $1,000 / (1 + 4.5%)²⁴ = $347.70

PV of coupon payments = $35 x 14.49548 (PV annuity factor, 4.5%, 24 periods) = $507.34

market price = $347.70 + $507.34 = $855.04

price in 3 years:

PV of face value = $1,000 / (1 + 4.5%)²⁰ = $414.64

PV of coupon payments = $35 x 13.00794 (PV annuity factor, 4.5%, 20 periods) = $455.28

market price = $414.64+ $455.28 = $869.92

price in 8 years:

PV of face value = $1,000 / (1 + 4.5%)¹⁰ = $643.93

PV of coupon payments = $35 x 7.91272 (PV annuity factor, 4.5%, 10 periods) = $276.95

market price = $643.93 + $276.95 = $920.88

price in 12 years:

PV of face value = $1,000 / (1 + 4.5%)² = $915.73

PV of coupon payments = $35 x 1.87267 (PV annuity factor, 4.5%, 2 periods) = $65.54

market price = $915.73 + $65.54 = $981.27

price in 13 years:

market price = $1,000 + $35 = $1,035