PART - B

Victorian Shipping Corporation (VSC) decided to increase the company ship's fleet a year ago To finance this decision the company management has decided to issue bonds. Last year, the yield on AAA-rated corporate bonds averaged approximately 5 per cent; one year later, the yield on these same bonds had climbed to about 6 per cent because the Reserve Bank of Australia increased interest rates during the year. Under these circumstances VSC issued a 10-year, 5 per cent coupon $1000 bond one year ago (on 1 January). The bond interest pays annually. Assume that the market rate on similar risk bonds was 5 per cent at the time the bonds were issued.

1. Compute the market value of the bond at the time of issue.
2. Compute the market value of the bond one year after issue if the market yield for similar risk bonds was 6 per cent.
3. Compute the capital gains yield, the current yield, and the total return that the bond would have generated for investors during the year.
4. If you invested in bonds at the beginning of the year (one year ago on 1 January), would you have been better off if you held long-term or short-term bonds? Explain.
5. Assume that interest rates stabilise at a rate of 6 per cent, and then they stay at this level indefinitely. What would be the price of the bond after six years had passed? Describe what should happen to the prices of these bonds as they approach their maturities.