Question

You have the following three bonds in portfolio that needs re-evaluation:

1. Bond 1 ORT
2. Bond 2 LOK
3. Bond 3 POL

For more information about the three bonds, please take a look at the bottom of this page.

You expect that market interest rates will remain stable for the next 5 years at 3%, but after year 5, you expect the yield curve to go up = interest rates will go to 4% for year 6-10.  

1. What is the Fair Value of Bond 1? Show calculations (5p)

Bond 1 ABC 2019-2024 (Jan 1 issued, paid back Dec 31 2024)

Coupon rate 3%, Annual Coupons

Current Price $1.000

Par Value $1.000

Answer 1

Fair value of a bond = sum of periodic cash flows discounted at the releveant market yield

Assuming that the market interest rates start from 2019, we have:

Note: This is assuming that the par value is 1,000. If it is $1 then fair value is 0.95142.