Question

Please show all working out and explain

There are two riskless bonds which mature at t = 2. The first is a zero coupon bond that pays a balloon of $ 1,200. The other is a coupon bond with an annual coupon of $100 and a balloon payment of $990. The current yield on a riskless bond that mature in one year is 10%, the annualized yield on a two-year bond is also 10%.

(i) What is the duration of the zero coupon bond? And of the coupon bond? Explain its economic meaning.

(ii) Suppose the interest rate at t = 1 is 8%. Find the percentage price change for the zero coupon bond. Suppose next the interest rate at t=1 is 12%: find again the percentage change for the coupon bond. Compare the findings obtained in the two cases and explain them.

(iii) Compute then the percentage change for the coupon bond when the interest rate at t = 1 is 8% and then when it is 12%. Compare with the result obtained in the previous point (ii) and discuss.​

Answer 1

Answer:

Consider a $1,000 zero-coupon bond that has two years until maturity. The bond is currently valued at $925, the price at which it could be purchased today. The formula would look as follows: (1000/925)^(1/2)-1. When solved, this equation produces a value of 0.03975, which would be rounded and listed as a yield of 3.98%.

 

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