Question:

An investor is planning to invest in the bond market and has the following choices:

Bond A:

This is a coupon bond from ABM Ltd. The bond has a face value of $1,000 and a coupon rate of 5% paid semi-annually. The bond matures in 8 years.

Bond B:

This is a zero-coupon bond from ABM Ltd. The bond has a face value of $1,000. Interest on this bond compounds semi-annually. The bond matures in 8 years.

The market rate of interest for both bonds is 4%.

Considering the above information, please answer the following:

1. Determine the value of both bonds. [2 bonds x 1.5 marks = 3 marks]
2. For both bonds, state if they sell at par or premium or discount. [2 marks]
3. Suppose the investor buys a zero-coupon bond of ABM Ltd.for the price (i.e., value) determined in (a)and then sells the bond for $710 after 4 years. Determine the realised yield for the investor. [2.5 marks]