David Ltd is planning to issue 5-year bonds with a face value of $1,000 to fund their new project in Japan. The current market rate is 7%. Assume that coupon payments will be semi-annual. The company is trying to decide between issuing a 8% coupon bond or a zero-coupon bond.

a) Is the coupon bond selling at par or at a discount or at a premium? Why? What about the zero-coupon bond? Is it selling at par or at a discount or at a premium? Why? (2 marks)

b) What is the price of the coupon bond? (Round to 2 d.p) (3 marks)

c) What will be the price of the zero-coupon bond? (Round to 2 d.p) (3 marks)

d) If the interest rate increases by 2%, which bond will have higher interest rate risk? Explain (Tip: refer to the bond theorems. No calculation needed) (1 mark)