Question
Let's assume you are observing two risk-free bonds, A and B, with two and three remaining to maturity, respectively, and face value of $ 1,000.
Let's assume you are observing two risk-free bonds, A and B, with two and three remaining to maturity, respectively, and face value of $ 1,000. The first bond has 9% coupon rate, the second one 10%. Both the bonds pay coupon annually. You also find that one year zero coupon government bond with face value of $100 is trading at $94.34, two-year zero coupon bond trading at $87.84 and three-year zero coupon bond trading $79.
(a) Let's say currently the market price of the bond A is 10% less than its fair value whereas the market price of the bond B is 10% higher than its fair value. At what price are these bonds currently trading at? (7 marks)
(b) Compute the yield to maturity for both bonds. Comment on your results. (3 marks)
(c) Let's say a Treasury bond was issued on 15 January, 2022 and matures in 15 January, 2024. The bond's face value is $ 1,000 and pays coupon of 10% annually. If this bond trades at its fair value today, i.e. 23rd May, 2022 and you decide to buy this bond, estimate the price that you will have to pay to the seller of the bond. (3 marks)
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