Question

Bonds can be priced using the bond pricing formula:

A 10 year bond was just issued that pays coupons every 6 months. The coupon rate is 5 percent per annum, the yield is 6 percent per annum and the principal is $100.

Which of the following statements about the numbers that should be input into the bond pricing formula is NOT correct? You do not have to price the bond, just state which inputs are not correct.

Select one:

a. T should be 20.

b. r should be 0.025

c. C should be $2.50.

d. F_T should be $100

e. The current price P₀ will be less than $100.

Answer 1

The following statments are correct:-

a). No of coupon Payment(T) = No of year to maturity*No of paymnets in a year

= 10 years*2

= 20

c). Face Value of Bond = $100

Semi-annual Coupon Payment (C) = $100*5%*1/2 (being semi-annual payment)

= $2.5

d). Face Value will be redemmed at the end of 10 years = $100

So, F_T is $100.

e). As per Inverse relationship between Price and Market Yield, the Price of bond is less than Face value when Yield is higher than coupon rate and Vice-versa.

Since Yield is 6% and Coupon rate is 5%, Yield is higher. Thus, Price will be less than $100

Hence, Option B is not Correct. Because when discounting the Payments of Bond, Market yield is used rather than coupon rate. hence, it should be 0.06/2 = 0.03

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