Question

You just started work at a wealth management firm and your boss asks you to evaluate a 6-year bond with a face value of $1,000 that, according to the prospectus, you can purchase next month (01-October-2018) when it is initially issued. The bond is designed to provide a 5.9% yield-to- market (YTM) and makes annual 01 October coupon payments. The underwriter has stated the issuer’s intention to sell the bonds at face value (par) and your plan is purchase the bonds accordingly for $1,000 apiece, meaning the coupon and the YTM will be the same on the date of sale.

If the YTM is expected to remain constant, what is the minimum priceyou would accept to sell the bond on September 30, 2021, the day before you receive the 3rd coupon payment?

A. $941.51

B. $1,029.50

C. $1,059.00

D. $1,061.00

E. $1,183.00

Answer 1

As the YTM of the bond is 5.90% and the face value if $ 1,000, this means that the coupon payment made during the year are:

= 5.90% * 1,000

= $ 59

Now as the bond's YTM is expected to remain constant during the lifetime and the person who will be hold the bond will receive coupon payments of $ 59 every year and in the last year $ 1,059 (Par Value + Last coupon payment ) will be paid.

In the given case as the person wants to sell the bond on the last date of the year , he will be foregoing the coupon payment for that year. So, the minimum value that the person should accept to sell the bond on September 30, 2021, when the coupon payment is due on 01 October is

Par value + Coupon Payment foregone

= 1,000 + 59

= $ 1,059