Consider two bonds: 1) a zero-coupon bond having a face value F and maturity 1 y
ID: 2808818 • Letter: C
Question
Consider two bonds: 1) a zero-coupon bond having a face value F and maturity 1 year; 2) a coupon bond with face value F, coupons C = 15 paid annually and maturity 3 years. Assume that the continuously compounded interest rate is 10%.
a) (5 pts) If F = 100, find at the end of which year the price of the second bond will be for the first time below 110?
b) (5 pts) If the price of the second bond is equal to 1.20 times the price of the first bond, find the (common) face value F ? (Round to the nearest thousandth)
Explanation / Answer
Ans a) Price of bond = coupon * (1 - (1+r)^-n))/r + face value/(1+r)^n
Price of bond today = 15*(1 - 1.1^-3)/.1 + 100/1.1^3
= $112.43
Price of bond after 1 year = 15*(1 - 1.1^-2)/.1 + 100/1.1^2
= $108.68
After 1 year bond price become less than $110
Ans b) Price of second bond today = $112.43
Price of 1st bond = $112.43/1.2 = $93.69
Face value of bond = $93.69 * (1.1) = $103.06