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XYZ Co has two types of bonds: Bond A and Bond B. There are 1000 units of Bond A; each unit has $100 face value, 5% coupon rate with semi-annual payments, and 10 years to maturity. There are 2000 units of Bond B; each unit has $100 face value, 8% coupon rate with semi-annual payments, and 20 years to maturity. The risk-free rate is 3%, default risk premium for Bond A and Bond B is 2%, maturity risk premium for 10-year maturity is 1 % and for 20-year maturity is 1.5%.

a. Determine the required rate of return for Bond A and for Bond B.

b. Determine the per unit value of Bond A and of Bond B. Are they premium bonds or discount bonds? Explain and discuss.

c. If the risk-free rate goes up from 3% to 4% due to inflation, what will be the rate of change in the value of Bond A and of Bond B? Which bond has a greater risk? Explain.

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