1. Consider a THREE-year coupon bond with a maturity value of $1000 that has just been be issued by Acme Corporation with a coupon rate of 5 %. Holders of these bonds will receive a coupon payment at the end of each of the next three years and will receive the face value of the bond at the end of the three-year period if it is held to maturity. Consider the situation of an investor who has just purchased one of these newly-issued bonds for a price of $1000. Coupon bonds similar in quality to Acme's bonds with three years to maturity are currently yielding a 5 % return. Suppose our investor sells this bond after one year. He received the coupon payment and sells the bond that now has two years remaining until maturity. At the time he sells the bond, bonds of similar quality with two years to maturity are yielding a 7% return a. How much should a rational investor be willing to pay for this bond (i.e. Acme's 3-year, 5 % coupon rate bond that now has 2 years to maturity)? Explain and show your work. b. Would the price have changed by a greater, lesser, or the same amount if this debt instrument had initially been issued as a four year bond instead of a three year bond? Explain c. Did the original investor (the person who bought the bond when it was initially issued by Acme) benefit or was he harmed by the rise in market interest rates? Explain and show the rate of return that he received by purchasing the bond and selling after one year 1. Consider a THREE-year coupon bond with a maturity value of $1000 that has just been be issued by Acme Corporation with a coupon rate of 5 %. Holders of these bonds will receive a coupon payment at the end of each of the next three years and will receive the face value of the bond at the end of the three-year period if it is held to maturity. Consider the situation of an investor who has just purchased one of these newly-issued bonds for a price of $1000. Coupon bonds similar in quality to Acme's bonds with three years to maturity are currently yielding a 5 % return. Suppose our investor sells this bond after one year. He received the coupon payment and sells the bond that now has two years remaining until maturity. At the time he sells the bond, bonds of similar quality with two years to maturity are yielding a 7% return a. How much should a rational investor be willing to pay for this bond (i.e. Acme's 3-year, 5 % coupon rate bond that now has 2 years to maturity)? Explain and show your work. b. Would the price have changed by a greater, lesser, or the same amount if this debt instrument had initially been issued as a four year bond instead of a three year bond? Explain c. Did the original investor (the person who bought the bond when it was initially issued by Acme) benefit or was he harmed by the rise in market interest rates? Explain and show the rate of return that he received by purchasing the bond and selling after one year
