QUESTION 4 20 MARKS 4.1 Assume we are at the beginning of this year, and you have a one-year investment horizon and are trying to choose among three bonds. All have the same degree of default risk and mature in 10 years. The first is a zero-coupon bond that pays R1 000 at maturity. The second has a 7.8% coupon rate and pays an annual coupon of R78 twice per year. The third has a 9.8% coupon rate and pays the R98 coupon once per year. a) If all three bonds are now priced to yield 7.8% to maturity, what are their prices? b) If you expect their yields to maturity to be 7.8% at the beginning of next year, what will their prices be then? c) What is your rate of return on each bond during the one-year holding period? (5 marks) 4.2 Two bonds were issued five years ago, with terms given in the following table: Issue size Maturity Current price (% of par) Current coupon Coupon adjusts Coupon reset rule Callable Call price Sinking fund 9% Coupon R250 million 20 years 93 9% Fixed coupon - 10 years after issue 106 None 9.9% R85-R112 Floating rate R280 million 15 years 98 5% Every year 1-year T-bill rate +2% 10 years after issue 102.50 None R97 - R102 Yield to maturity Price range since issued a) Why is the price range greater for the 9% coupon bond than the floating-rate bond? b) What factors could explain why the floating-rate bond is not always sold at par value? c) Why is the call price for the floating-rate bond not of great importance to investors? d) Is the probability of call for the fixed-rate bond high or low? e) If the firm were to issue a fixed-rate bond with a 15-year maturity, callable after five years at 106, what coupon rate would it need to offer to issue the bond at par value? f) Why is an entry for yield to maturity for the floating-rate bond not appropriate? (15 marks)