Two bonds have the following terms: Bond A Bond B Principal$1,000 Principal$1,000 Coupon8% Coupon7.6% Maturity10 years Maturity10 years Bond B has an additional feature: It may be redeemed at par after five years (i.e., it has a put feature) But bonds were initially sold for their face amounts (i.e., $1,000). A.If interest rates fall to 7 percent, what will will be the price of each bond? B.If interest rates rise to 9 percent, what will be the decline in the price of each bond from its intiial price? C.Given your answers to questions (a) and (b), what is the trade-off implied by the put option in bond B? D.Bond B requires the investor to forgo $4 a year (i.e., $40 if the bond is in existence for ten years). If interest rates are 8 percent, what is the present value of this forgone interest? If the bond had lacked the put feature but had a coupon of 7.6 percent and a term to maturity of ten years, it would sell for $973.16 when interest rates were 8 percent. What, then, is the implied cost of the put option?

NOTE: As per our policy, we only answer up to three sub-questions. Therefore the first three…

Answered: f interest rates fall to 7 percent,…

EBK CFIN

6th Edition

ISBN:9781337671743

Author:BESLEY

Publisher:BESLEY

Chapter6: Bonds (debt) - Characteristics And Valuation

Section: Chapter Questions

Problem 4PROB

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Question

Two bonds have the following terms:

Bond A

Bond B

Principal

$1,000

Principal

$1,000

Coupon

7.6%

Maturity

10 years

Maturity

10 years

Bond B has an additional feature: It may be redeemed at par after five years (i.e., it has a put feature) But bonds were initially sold for their face amounts (i.e., $1,000).

If interest rates fall to 7 percent, what will will be the price of each bond?

If interest rates rise to 9 percent, what will be the decline in the price of each bond from its intiial price?

Given your answers to questions (a) and (b), what is the trade-off implied by the put option in bond B?

Bond B requires the investor to forgo $4 a year (i.e., $40 if the bond is in existence for ten years). If interest rates are 8 percent, what is the present value of this forgone interest?

If the bond had lacked the put feature but had a coupon of 7.6 percent and a term to maturity of ten years, it would sell for $973.16 when interest rates were 8 percent.

What, then, is the implied cost of the put option?