Question Two

Mutale and Luyando are vice presidents of Copperbelt Money Management (CMM) and co-directors of the companys pension fund management division. A major new client, the Nkana League of Cities, has requested that CMM present an investment seminar to the mayors of the represented cities. Mutale and Luyando, who will make the presentation, have asked you to help them by answering the following questions.

(a)What ae a bonds key features?

(b) How is the value of any asset whose value is based on expected future cash flows determined?

(c) What is the value of a 10-year, $1,000 par value bond with a 10% annualcoupon, paid semi-annually, if its required return is 10%?(2 marks)

(d) (1) What is the value of a 13% coupon bond that is otherwise identical to the bond described in Part c above?Would we now have a discount or a premium bond?

(2) What is the value of a 7% coupon bond with these characteristics? Would we now have a discount orpremium bond?

(3) What would happen to the values of the 7%, 10%, and 13% coupon bonds over time if the required return increased to 13%?

(e) (1) What is the yield to maturity on a 10-year, 4% semi-annual coupon, $1,000 par value bond that sells for $887.00 and another that sells for $1,134.20? What does the fact that it sells at a discount or at a premium tell youabout the relationship between r_d and the coupon rate?

(2) What are the total return, the current yield, and the capital gains yield for the premium bond in part e (1)? Assumethat it is held to maturity and the company does not default on it. (3marks)