,INV3702 Assignment 2 (COMPLETE ANSWERS) Semester
2 2024 - DUE September 2024 ; 100% TRUSTED Complete,
trusted solutions and explanations.
Question 1 You observe the following sovereign bonds. Time to
maturity Coupon Yield to maturity Bond A 1 year 6% 2.342%
Bond B 1 year 0% 2.350% Bond C 2 years 6% 2.496% Bond D
2 years 0% 2.500% Bond E 3 years 6% 2.711% Bond F 3 years
0% 2.725% Determine whether Bond C is overvalued,
undervalued or fairly valued. All coupons are paid annually. (3)
To determine whether Bond C is overvalued, undervalued, or
fairly valued, we need to compare its price based on the yield to
maturity (YTM) with its current price. To do this, we'll follow
these steps:
1. Calculate the Price of Bond C: Bond C has a coupon rate
of 6% and a YTM of 2.496%. It pays annual coupons and
has 2 years to maturity.
The price of a bond can be calculated using the formula:
Price=C(1+y)1+C(1+y)2+F(1+y)n\text{Price} =
\frac{C}{(1 + y)^1} + \frac{C}{(1 + y)^2} + \frac{F}{(1 +
y)^n}Price=(1+y)1C+(1+y)2C+(1+y)nF
where:
o CCC is the annual coupon payment,
o yyy is the yield to maturity,
o FFF is the face value of the bond (usually $100),
, o nnn is the number of years to maturity.
For Bond C:
o Annual coupon payment C=6%×$100=$6C = 6\%
\times \$100 = \$6C=6%×$100=$6,
o Yield to maturity y=2.496%=0.02496y = 2.496\% =
0.02496y=2.496%=0.02496,
o Face value F=$100F = \$100F=$100,
o Time to maturity n=2n = 2n=2 years.
Plug these values into the formula:
Price of Bond C=6(1+0.02496)1+6(1+0.02496)2+100(1+0.
02496)2\text{Price of Bond C} = \frac{6}{(1 +
0.02496)^1} + \frac{6}{(1 + 0.02496)^2} + \frac{100}{(1
+ 0.02496)^2}Price of Bond C=(1+0.02496)16
+(1+0.02496)26+(1+0.02496)2100
Breaking it down:
Price of Bond C=61.02496+61.04994+1001.04994\text{Pri
ce of Bond C} = \frac{6}{1.02496} + \frac{6}{1.04994} +
\frac{100}{1.04994}Price of Bond C=1.024966+1.049946
+1.04994100
Price of Bond C=5.854+5.710+95.146\text{Price of Bond
C} = 5.854 + 5.710 +
95.146Price of Bond C=5.854+5.710+95.146
Price of Bond C=106.710\text{Price of Bond C} =
106.710Price of Bond C=106.710
2. Compare Bond C’s Price to Bond D’s Price:
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