Question
Two 20-year maturity mortgage-backed bonds are issued. The first bond has a par value of $10,000 and promises to pay an 8.5% annual coupon, while
Two 20-year maturity mortgage-backed bonds are issued. The first bond has a par value of $10,000 and promises to pay an 8.5% annual coupon, while the second is a zero coupon bond that promised to pay $10,000 (par) after 20 years, including accrued interest at 8%. At issue, bond market investors require a 9.5% interest rate on both bonds.
A. (5 points) What is the initial price of each bond?
B. (5 points) Assume both bonds promise interest at 8.5%, compounded semiannually. What will be the initial price of each bond?
C. (5 points) If market rates fall to 8.25% at the end of ten years, what will be the value of each bond, assuming annual payments as in 2A?
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