Mary Gold\'s broker has shown her two bonds. Each has a maturity of five years,
ID: 2763269 • Letter: M
Question
Mary Gold's broker has shown her two bonds. Each has a maturity of five years, a par value of $1000 and a yield to maturity of 12%. Bond A has a coupon interest rate of 6% paid annually. Bond B has a coupon interest rate of 14% paid annually. Calculate the selling price for each of the bonds. Mary has $20 000 to invest. Judging on the basis of the price of the bonds, how many of either one could Mary purchase if she were to choose it over the other? (Mary cannot really purchase a fraction of a bond, but for purposes of this question pretend that she can.) Calculate the yearly interest income of each bond on the basis of its coupon rate and the number of bonds that Mary could buy with her $20 000. Assume that Mary will reinvest the interest payments as they are paid (at the end of each year) and that her rate of return on the reinvestment is only 10%. For each bond, calculate the value of the principal payment plus the value of Mary's reinvestment account at the end of the five years. Why are the two values calculated in part d different? If Mary were worried that she would earn less than the 12% yield to maturity on the reinvested interest payments, which of these two bonds would be a better choice?Explanation / Answer
Years
Particulars
Cash flow A
Cash flow B
PVF@12%
Present value A
Present value B
1
Dividend
60
140
0.892857143
53.57
125.00
2
Dividend
60
140.00
0.797193878
47.83
111.61
3
Dividend
60
140.00
0.711780248
42.71
99.65
4
Dividend
60
140.00
0.711780248
42.71
99.65
5
Dividend
60
140.00
0.635518078
38.13
88.97
Redemption value
1000
1000
0.635518078
635.52
635.52
Total
860.47
1160.40
No of share Mary can purchase and interest value
Particulars
Bond A
Bond B
Investment amount
20000
20000
Selling price per share
860.47
1160.40
No of shares
23 (23.24)
17 (17.24)
Interest (yearly)
23*60(interest )
17*140(interest)
1380
2380
- Table showing selling price of bond A and B
Years
Particulars
Cash flow A
Cash flow B
PVF@12%
Present value A
Present value B
1
Dividend
60
140
0.892857143
53.57
125.00
2
Dividend
60
140.00
0.797193878
47.83
111.61
3
Dividend
60
140.00
0.711780248
42.71
99.65
4
Dividend
60
140.00
0.711780248
42.71
99.65
5
Dividend
60
140.00
0.635518078
38.13
88.97
Redemption value
1000
1000
0.635518078
635.52
635.52
Total
860.47
1160.40