Question

1. Assume that you are holding two bonds. A 30-year zero coupon bond, and 30-year coupon bond with 2% coupon. You are not planning to hold the bonds till maturity. If you expect the interest rates to decrease sharply, which bond would you rather get rid-off (sell)? explain

2. Read this case carefully. “You relative asks you to lend him money and promised to pay you 8% per year. You know that the bank offers 5% return on a saving account. You declined to lend your relative, and, instead, you deposited you money in the bank to earn 5%. Your relative ended up taking a loan from the bank at 12%”. Based on what we covered in class, comment generally on this case

Answer 1

SOLUTION:-

1) 30 years coupan bond with 2% coupan will be sold off because these bonds interest will be decline in future hence these bonds will be sold off. As zero coupan bonds have no relation with interest payments as face value will be paid at maturity at par.

Hence 30 years coupan bond with 2% coupan will be sold.

2) Bank offers 5% interest on saving account and lend that amount to relative at 12%. Difference of 12% interest on loan offered and 5% interest given on saving account is profit of bank that is ( 12 - 5 ) 7%.

7% is profit that bank earn and that is used in paying of salaries bank staff and profits to bank organisation.

This is incentive for bank of playing vital role in accepting deposits from people and lending loan to people which is one of function of commercial bank.

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