I can’t understand the relationship between 1 year $600, 2year $600, 3 year $10600 equivalent as $10,000. Could you please explain. ------------------- An investor gathered the following information on three zero-coupon bonds: 1-year, $600 par, zero-coupon bond valued at $571 2-year, $600 par, zero-coupon bond valued at $544 3-year, $10,600 par, zero-coupon bond valued at $8,901 Given the above information, how much should an investor pay for a $10,000 par, 3-year, 6 percent, annual-pay coupon bond? A) $10,000. B) $10,016. C) $10,600. D) Cannot be determined by the information provided. Your answer: A was incorrect. The correct answer was B) $10,016. A coupon bond can be viewed simply as a portfolio of zero-coupon bonds. The value of the coupon bond should simply be the summation of the present values of the three zero-coupon bonds. Hence, the value of the 3-year annual-pay bond should be $10,016 (571 + 544 + 8,901).
chinni, that’s the discounted cash flow approach. PV = sum of discounted cash flows. Combination of the three bonds has the same cash flows as a 3 year 6 percent annual-pay coupon bond. As a result, its price (PV) is equal to the sum of their prices (PVs). does it make sense to you?
Cash flow additivity principle
Thanks for your replies. I got it.