Question
General Motors (GM) wants to issue bonds for an investment project that will revolutionize the market. In turn, Ford does not want to be left
General Motors (GM) wants to issue bonds for an investment project that will revolutionize the market. In turn, Ford does not want to be left behind and plans to issue bonds to invest in a similar project. GM will issue bonds with face value of USD 1,000,000, a coupon of 4% (Nominal Annual Semi-annual Due) and a yield to maturity of 6% (Nominal Annual Semi-annual Due). On the other hand, Ford will issue bonds of the same face value, but with a coupon of 7% (Nominal Annual Semi-annual Due) and a yield to maturity of 4% (Nominal Annual Semi-annual Due). Both bonds have a maturity of 9 years and interest is paid semi-annually.
(a) Which of the 2 bonds is cheaper? Solve and say why (b) Ford would like his bonds to sell for $400,000 while maintaining the yield and face value. What should be the coupon in this case? (c) If the yield to maturity of the GM bonds rises to 7.5%, how much does the price of the bond change in USD? (d) Calculate the duration of both bonds in semesters. (e) Calculate the duration of the bonds after the changes executed in b and c, in semesters. Discuss the evidence for observed relationships between prices, the coupon rate, and the duration of bonds.
(f) Calculate the modified duration and a second-order approximation for the bonds in point 2 (before the proposed changes), for a Y of 100 basis points
Use Excel.
Thank you!
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