I’m not sure where they are getting this formula for calculating the bond price? Can anyone direct me to a LOS or section in the CFA/schweser curriculum? Thanks! Suppose that a corporate bond and a government bond have equivalent characteristics. They both have a coupon rate of 6% paid annually and have two years remaining to maturity. Assuming a flat government term structure of 7% which of the following is a possible price of the corporate bond? A) 98.19. B) 97.76. C) 101.35. Your answer: C was incorrect. The correct answer was B) 97.76. Since the corporate bond involves credit risk and the government bond doesn’t. The corporate bond price has to be less than the government bond price which is computed as follows: Government Bond Price = 6 / 1.07 + 106 / 1.072 = 98.19 --------------------------------------------------------------------------------
that formula is just discounting the cash flows of the bond. But forget that, It’s a simple TVM calculation. FV 100 IY 7 N 2 PMT 6 CPT PV = 98.19 so thats the price of the gov’t bond. Since a corporate has credit risk, it must be priced lower then an otherwise equivalent gov’t bond - hence B is the only option.
^ fantastic way to see and answer this question. thanks for your help!
yohji, where is that question from? Qbank?
^ yesssir!