Assume that you invest $10,000 in a 25 year, US Treasury Bond paying 10% interes
ID: 2654174 • Letter: A
Question
Assume that you invest $10,000 in a 25 year, US Treasury Bond paying 10% interest compounded semi-annually. You invest another $10,000 in a 25 year, US Treasury zero coupon bond paying 10% interest compounded semi-annually, giving a year 25 maturity value of $114,674. Further assume that one week after you buy these bonds, a major change occurs in financial markets, interest rates jump to 12% per year compounded semi-annually. You need to sell these bonds to meet other financial obligations. Calculate your one-week percent loss from each bond investment.
A) 1st Investment: percent loss = 15.76%; 2nd Investment: percent loss = 33.15%
B) 1st Investment: percent loss = 13.97%; 2nd Investment: percent loss = 37.74%
C) 1st Investment: percent loss = 15.76%; 2nd Investment: percent loss = 37.74%
D) 1st Investment: percent loss = 13.97%; 2nd Investment: percent loss = 33.15%
Explanation / Answer
After interest rate changes 10% to 12%
1st Investment:
Value of Treasury Coupon Bond = pv(rate,nper,pmt,fv)
rate = 12%*1/2 = 6%
nper = 25*2 = 50
pmt = 10%*10000*1/2 = 500
fv = 10000
Value of Treasury Coupon Bond = pv(6%,50,500,10000)
Value of Treasury Coupon Bond = $ 8423.81
Percentage loss = (8423.81-10000)/10000
Percentage loss = 15.76%
2nd Investment:
Value = 114674/(1+12%/2)^(25*2)
Value = $ 6225.46
Percentage loss = (6225.46-10000)/10000
Percentage loss = 37.74%
Answer
C) 1st Investment: percent loss = 15.76%; 2nd Investment: percent loss = 37.74%