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5. Answer the following questions on bonds. [20 marks] a) You are working as a summer intern at Capula Investment Management, a London-based hedge fund focusing on fixed income markets. The fixed income strategy desk analysts have estimated spot interest rates as follows Year Spot Interest Rate 1 0.25% 2 0.50% 3 0.75% 4 1.00% 5 1.25% (i) You are asked to calculate the present values of the following government bonds with annual coupon payments. Assume annual compounding and a Face Value of $1,000. 0.5 percent coupon (annual coupon rate), five-year maturity. 1.5 percent coupon (annual coupon rate), five-year maturity. [6 marks) (ii) Calculate the yield to maturity of two bonds in part (i). [4 marks) (iii) Explain why the 0.5 percent coupon bond is selling at discount (Price Face Value). [4 marks) b)(i) Two bonds have identical times to maturity, coupon rates and face value. One is callable at $105, the other (a straight bond) is selling at $110. Which bond should have the higher yield to maturity? Why? [3 marks) (ii) A puttable bond always has a higher price and a lower yield to maturity than a straight bond. Why? [3 marks]