Two 25-year maturity mortgage-backed bonds are issued. The first bond has a par value of $10,000 and

Question:

Two 25-year maturity mortgage-backed bonds are issued. The first bond has a par value of $10,000 and promises to pay a 10.5 percent annual coupon, while the second is a zero coupon bond that promises to pay $10,000 (par) after 25 years, including accrued interest at 10 percent. At issue, bond market investors require a 12 percent interest rate on both bonds.

a. What is the initial price on each bond?

b. Assume both bonds promise interest at 10.5 percent, compounded semiannually. What will be the initial price for each bond?

c. If market interest rates fall to 9.5 percent at the end of five years, what will be the value of each bond, assuming annual payments as in (a) (state both as a percentage of par value and actual dollar value)?

Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest... Par Value
Par value is the face value of a bond. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. The market price of a bond may be above or below par,...

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