Consider three risk free Eurobonds ( which pay coupons annually). Their times to
ID: 2638650 • Letter: C
Question
Consider three risk free Eurobonds ( which pay coupons annually). Their times to maturity, coupon rates and current market prices (based on a face value of$100) are as follows: Bond A 1 yr 9% $101.25; Bond B 2 yrs 8% 99.75; Bond C 3 yrs 7% $96.00. a. What are the yields to maturity for Bond A, B and C, respectively? b. If arbitrage opportunities are driven out of the market, what should the current prices of one-, two-, and three-year zero- coupon bonds with a face value of $1? c. What should be the spot yields on one-, two-, and three-year zero-coupon bonds? d. What should the annuity yield be on one-, two-, and three-year annuity? e. A three-year 9.25% par value corporate bond was recently issued in the market. What is the default risk premium of three corporate bond?
Explanation / Answer
Ans A
YTM of A bond= C+F-P/n/F+P/2
C=Coupon, F= Face Value, P=Price, n=No. of year sto maturity
Bond A Value= 9%+100-101.25/1/100+101.25/2=7.65%
Bond B Value=8%+100-99.75/2/100+99.25/2= 8.14%
Bond C Vlue=7%+100-96/3/100+96/2= 8.57%
Ans B.
Zero Couon Bond Value=F/(1+rate)^t
F=Face Value, T=No. of years to maturity
1year Zero coupon Bond= 1/1.09= 0.917
2 Year Zero Coupon Bond= 1/1.1664=0.600
3Year Zero Coupon Bond= 1/1.225043=0.816
Ans e.
3 Year Coupon pAying bond at 9.25%=9.25%+100-96/3/100+96/2=10.59%
Riak free 3 year was 7%, therefore Risk premium is 10.59-7=3.59%