QUESTION 1 (18 marks) Your broker has shown you two bonds. Each has a maturity of 10 years, a par value of RM1,000, and a yield to maturity of 5%. Bond A has a coupon interest rate of 4% paid annually. Bond B has a coupon interest rate of 7% paid annually.

a. Calculate the selling price for each of the bonds. (2 marks)

b. What is Bond A called? Bond B? (2 marks)

c. You have RM40,000 to invest. Judging on the basis of the price of the bonds in (a), how many of either one could you purchase if you were to choose it over the other? (3 marks)

d. Calculate the yearly interest income of each bond on the basis of its coupon rate and the number of bonds you could buy with your RM40,000. (3 marks)

e. Assume that you will reinvest the interest payments as they are paid (at the end of each year) and that your rate of return on the reinvestment is only 4.5%. For each bond, calculate the value of the principal payment plus the value of your reinvestment account at the end of the 10 years. (4 marks)

f. Why are the values calculated in part (e) different? If you were worried that you would earn less than 5% yield to maturity on the reinvested interest payments, which of these two bonds would be a better choice? (4 marks)