3. Bond Valuation (22 Points) IOU Corporation wants to issue two bonds: a zero-coupon bond and a coupon bond. The zero-coupon bond has a maturity of 10 years and is discounted annually, while the coupon paying bond has a maturity of 20 years and pays coupons on a monthly basis. The annual yield-to-maturity (YTM) on zero coupon 10 year US government bonds is 3%, while the annual YTM on 20 year coupon paying US government bonds is 4% (The governinent bond also pays coupons on a monthly basis). In addition, the credit spread on 10 year zero coupon bonds is 3%, while the credit spread on 20 year coupon bonds is 4%. All bonds have a face value of $100. Both bonds issued by IUO Corporation pay 5% coupon rate. Given this information, answer the following: (a) 5 Points. Find the coupon payment that IOU's 20 year coupon bond will pay every period. After that, draw a timeline that lists all of the cash flows (paid and received) if an investor holds that bond until maturity. (b) 7 Points. How would you calculate the current market price of IOU's 20 year coupon paying bond? (NOTE: You only need to write down the formula you would need to plug into a financial calculator to find the price.) (c) 5 Points. If an investor buys the zero-coupon 10 year IOU bond and sells it after 8 years, write down the expression that would determine at what price the investor would sell that bond at (d) 5 Points. When interest rates change, bond prices change as well. Intuitively, why is that the case? Explain. 3. Bond Valuation (22 Points) IOU Corporation wants to issue two bonds: a zero-coupon bond and a coupon bond. The zero-coupon bond has a maturity of 10 years and is discounted annually, while the coupon paying bond has a maturity of 20 years and pays coupons on a monthly basis. The annual yield-to-maturity (YTM) on zero coupon 10 year US government bonds is 3%, while the annual YTM on 20 year coupon paying US government bonds is 4% (The governinent bond also pays coupons on a monthly basis). In addition, the credit spread on 10 year zero coupon bonds is 3%, while the credit spread on 20 year coupon bonds is 4%. All bonds have a face value of $100. Both bonds issued by IUO Corporation pay 5% coupon rate. Given this information, answer the following: (a) 5 Points. Find the coupon payment that IOU's 20 year coupon bond will pay every period. After that, draw a timeline that lists all of the cash flows (paid and received) if an investor holds that bond until maturity. (b) 7 Points. How would you calculate the current market price of IOU's 20 year coupon paying bond? (NOTE: You only need to write down the formula you would need to plug into a financial calculator to find the price.) (c) 5 Points. If an investor buys the zero-coupon 10 year IOU bond and sells it after 8 years, write down the expression that would determine at what price the investor would sell that bond at (d) 5 Points. When interest rates change, bond prices change as well. Intuitively, why is that the case? Explain
