Bond A is a $1,000, 6% quarterly coupon bond with 5 years to maturity. (a) If you bought Bond A today at a yield (APR) of 8%, what is your purchase price? Is this a premium or discount bond? Why?) (b) One year later, Bond A's YTM (APR) has gone down to 6% and you sell it immediately after receiving the coupon. (i) What is the current yield? (ii) What is the capital gains yield?
Debenture Valuation
A debenture is a private and long-term debt instrument issued by financial, non-financial institutions, governments, or corporations. A debenture is classified as a type of bond, where the instrument carries a fixed rate of interest, commonly known as the ‘coupon rate.’ Debentures are documented in an indenture, clearly specifying the type of debenture, the rate and method of interest computation, and maturity date.
Note Valuation
It is the process to determine the value or worth of an asset, liability, debt of the company. It can be determined by many processes or techniques. Many factors can impact the valuation of an asset, liability, or the company, like:
Bond A is a $1,000, 6% quarterly coupon bond with 5 years to maturity.
(a) If you bought Bond A today at a yield (APR) of 8%, what is your purchase price? Is this a
premium or discount bond? Why?)
(b) One year later, Bond A's YTM (APR) has gone down to 6% and you sell it immediately after
receiving the coupon.
(i) What is the current yield?
(ii) What is the
(iii) What is the one-year total
per quarter during the holding period?
(iv) Can Bond A’s one-year total rate of return be determined correctly by simply adding up
the current yield and the capital gains yield? Explain your answer without calculations.
(c) Consider two other bonds: Bond B and Bond C.
Bond B: A $1,000, 7% quarterly coupon bond with 4 years to maturity
Bond C: A $1,000 zero coupon bond with 2 years to maturity
(i) Without calculation, briefly explain which bond in the following pairs has higher
interest rate risk.
1) Bond A vs. Bond B
2) Bond B vs. Bond C
(ii) Suppose you are holding a bond portfolio made up of Bonds A and B for long-term
investment purpose. If you are predicting the general interest rate to decrease in the next
year (i.e., the coming quarters), what should you do to your portfolio to maximize your
return?
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