Question
There is a 5% coupon, $1000 face value, 5-year, risk-free government bond that's selling for $1000. That bond was used to create 5-year, $1000 face
There is a 5% coupon, $1000 face value, 5-year, risk-free government bond that's selling for $1000. That bond was used to create 5-year, $1000 face value, zero coupon bond and a single strip-bond composed of all of the bond's coupon payments. When these bonds are priced by the market, the discount rates on them will not be the same. Why not? Be specific. Suppose I tell you that one of them has a return of 5.5% and the other 4.5%. Which bond would have the 5.5% return? Why? What metric could you use to justify this? Show all work and do not use a finance calculator or excel.
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