Question
During the class we established the fact that interest rates(discount rates) are negatively aecting the PV. Afterwards, we concluded that if an investor is intersested
During the class we established the fact that interest rates(discount rates) are negatively aecting the PV. Afterwards, we concluded that if an investor is intersested in getting a certain yield from an investment, she can calculate the fair price for the bond by discounting the future inows by that yield. If the market price (which will be a proxy for average expected yield) is lower, then the investor will buy the bond. Imagine a scenario of the following investing decision: buy a treasury bond with face value of $1000 and $100 coupons for 30 years that sells for $1280, or a treasury note with similar face value that has 10 years of maturity, issues $70 coupons every year and is selling for $1000.
(a) Calculate the YTM for both using excel. Which one will you pick?
(b) Suppose something happened in between 2nd and 3rd year and now the similar bonds give 10% less yield(i.e. ytm for both is reduced by 10%). Calculate your loss/gain from both investment options.
(c) Consider a scenario where you bought the T-Bond and after the rst year the yield for similar bonds is 15% higher. Did you have loss or gain from that? A friend of yours, on the other hand, got the T-Note. How much should the yield of thet T-Note change, in order for your friend to experience similar gain/loss?
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