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An investment bank purchased a Treasury bond at a government bond auction today. This bond has exactly 5 years to maturity and will pay annual
- An investment bank purchased a Treasury bond at a government bond auction today. This bond has exactly 5 years to maturity and will pay annual coupons of 2% per annum. All bonds in this issue (i.e. Treasury bonds with a coupon rate of 2% per annum paid yearly with 5 years to maturity) are currently trading in the bond market now at their face value of $1,000,000. Rather than just buy-and-hold this bond, the investment bank decides to strip the coupon payments off this newly issued 5 year to maturity bond to create a zero coupon bond and a separate 5 year income only annuity; rights to payments from the zero coupon bond and the annuity stream will be sold to investors.
- If the zero coupon bond created can be sold at a yield of 1.5% per annum (paid yearly), what is its principle stream worth?
- What is the income stream (annuity of coupons) sold for at the yield of 1.5% per annum (paid yearly)?
- What is the dollar (and percent) gain made by the investment bank? Briefly comment on this transaction from the investment banks perspective.
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