Question
FLY HIGH Plc is considering an investment in one of two corporate bonds that are being proposed for issue by two different listed companies. Both
FLY HIGH Plc is considering an investment in one of two corporate bonds that are being proposed for issue by two different listed companies. Both bonds have a par value of $100 and pay coupon interest on an annual basis. The market price of the first bond is $105.95. Its coupon rate is 6.1% and it is due to be redeemed at par in six years time. The second bond is about to be issued with a coupon rate of 4.2% and will also be redeemable at par in six years time. Both bonds are expected to have the same gross redemption yields (yields to maturity). When choosing bonds for investment, FLY HIGH Plc considers duration to be an important factor and therefore need such information in respect of each of the two bonds.
Required:
(a) Explain and discuss the relationship between coupon rate, yield to maturity and the price of redeemable corporate bonds. [6 Marks]
(b) Calculate the Macaulay duration of both bonds that FLY HIGH Plc is considering for investment [7 Marks]
(c) Discuss the usefulness of Macaulay duration as a measure of interest rate risk in the bond markets.
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