A 5-year, 10% annual coupon bond has a par value of $1,000. The current market required rate of return is 9%.

Required:

1. a) Derive the bond value. Is the bond traded at premium, discount, or at par?

   [3 marks]

2. b) If the current market trading price of the bond is $1010, whats your strategy in trading the

3. bond? Why?

   [2 marks]

4. c) Define the term spot rate. Why do people sometimes use spot rates in bond valuation

   instead of a single market rate?

   [4 marks]

5. d) A bond that matures in 2 years has a coupon rate of 4% and pays coupon semi-annually. Its

   face value is $1000. The spot rates are 3% for 6 months, 3.5% for 1 year, 4% for 1.5 years, and 4.5% for 2 years. Derive the bond value.

   [2 marks]

e) Explain why long term bonds are more sensitive to interest rate changes?

[4 marks]