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B4. Suppose the Australian government issues two different bonds, both with maturities of two years. Each bond has the same coupon rate and the same
B4. Suppose the Australian government issues two different bonds, both with maturities of two years. Each bond has the same coupon rate and the same face values, but Bond A pays annual coupons, whereas Bond B pays semi-annual coupons. The figure below presents the cash flows from each bond and divides the time between the issuance and maturity into four periods. Assume that the yield to maturity of each bond is positive and that the yield curve is flat. 0.5 1 1.5 2 Period 1 Period 2 Period 3 Period 4 + Bond A cash-flows C+Par Bond B cash-flows C/2 C/2 C/2+Par B4a. At time zero (i.e. at the beginning of Period 1): B4a.1. Which of the bonds (A or B) will have the higher price? Why? [1.5 marks] B4a.2. Which of the bonds (A or B) will have the higher duration? Why? [1.5 marks] C/2 B4b. In 19 months: B4b.1. Which of the bonds (A or B) will have the higher price? Why? [1.5 marks] B4b.2. Which of the bonds (A or B) will have the higher duration? Why? [1.5 marks]
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