Question

Suppose you manage the UM endownment. You have invested in $10m worth of 3 years zero-coupon French government bonds with a 3.2% yield. When mooty's credit agency upgraded French government debt yesterday their yields went down 50bps.

What effect did this have on your investment? Assume the bonds have $1,000 face value.

1.The bond price is _______ 1,080.20 / 938.95 / 1,000.00 / 909.83

2. The total number of bonds that you can purchase is ______ 10,991.05 / 10,650.24 / 9,257.57 / 10,000

3. The changes in bond price is _______ -$13.65 / +$13.65 / -$93.89 / +$93.89

4. The changes in your investment value is __________ +$15,000 / -$150,000 / + $150,000 / - $15,000

Answer 1

Solution:

50 bps is equal to 0.5%,thus new yield is 2.7%(3.2%-0.5%).

1.Since given bond is zero coupon bond,thus price of bond is equal to present value of maturity value at the end of 3rd year.Calculation is as follow;

Bond Price=Maturity value/(1+Yield)^Years to maturity

=$1000/(1+0.032)^3

=$909.83

Thus bond price is 909.83

2.Total number of bonds that can be purchased is;

=Available fund/Price per bond

=$10,000,000/$909.83

=10,991.06

Thus correct answer is 10,991.05

3.Calculation of change in bond price:

New Bond price=Maturity value/(1+new yield)^Years to maturity

=$1000/(1+0.027)^3

=$923.18

Thus change in bond price is:

=New price-Original price

=$923.18-$909.83

=$13.35

Thus correct answer is +$13.65

4.Calculation of change in investment value:

Cahnge in investment value=Change in price*No. of bond

=$13.65*10,991.05

=$150,027.83

Thus correct answer is + $150,000