Question
There is a 5% coupon, $1000 face value, 5-year, risk-free government bond thats selling for $1000. That bond was used to create a 5-year, $1000
There is a 5% coupon, $1000 face value, 5-year, risk-free government bond thats selling for $1000. That bond was used to create a 5-year, $1000 face value, zero coupon bond and a single strip-bond composed of all of the bonds 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? Please show all work and do not use excel or a finance calculator.
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