Bonds

A newly-issued ten-year option-free bond is valued at par on June 1, 2000. The bond pays an annual coupon of 8.0%. On June 1, 2003, the bond has a yield-to-maturity of 7.1%. Assume that the first coupon is reinvested at 8.0% and the second coupon is reinvested at 7.0%. The future bond price of the bond on June 1, 2003, is closest to: a. 100.00% of par. b. 105.40% of par c. 104.80% of par. d. 104.90% of par.

B? I just took the PV of the bond with N=8 I=7.1 PMT=80 FV=1000

I would say C.i did the same calculation as LongOnCFA but N=7.

N=7 I/Y = 7.1 FV = 100 PMT = 8 CPT–>PV = 104.8334 Is it C? - Dinesh S

I got C as well

C

How does the coupon reinvestment affect the valuation?

B? I put in the CF (C1=8,N=7,C2=108) , I=7.1, calculate NPV = 105.35

Sorry for the delay …The question is from passmaster and Choice “c” is correct. The answer is derived based on the following calculator inputs: N = 7; I/Y = 7.1; PMT = 8; FV = 100 Compute PV = 104.8335 , or 104.8335% of par But i dont understand why N= 7 i thought it should be 8. and why PMT = 8 ? how to interpret - “Assume that the first coupon is reinvested at 8.0% and the second coupon is reinvested at 7.0%” Thanks.

This is how I thought of it… For N: If I purchase at 6/2003, I am going to receive payments in 04, 05, 06, 07, 08, 09 , 10. Counting the payments there, it is 7. The bond will mature in 7 years from June 2003… that’s why n =7. For PMT: If par is 100 and the coupon rate is 8%, then the payment will be (100 * 8%) = 8 Ignore the “Assume that the first coupon is reinvested at 8.0% and the second coupon is reinvested at 7.0%” You are not trying to calculate the yield from issue to maturity. You are trying to calculate the market price of the bond @ 6/2003. However the previous owner invested his interest payments does not affect the price you are willing to pay for the bond. N = 7 i - 7.1 PMT = 8 FV = 100 PV = 104.83350 C

makes sense. Thanks apcarlso !