Question

QUESTION 2

Part A: A company offers to sell you a bond, with a par value of $1000, for $604.5. Annual coupons of $50 will be paid until the bond matures 10 years from now, at which time it will be redeemed for $1000. The next coupon will be paid a year from today. What interest rate would you earn if you bought this bond at the offer price?

a. 8.0%

b. 8.5%

c. 9.0%

d. 11.0%

e. 12.0%

Part B: Niendorf Corporation's 5-year bonds yield 7.75%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Niendorf's bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf's bonds?

a. 1.42%

b. 2.10%

c. 2.17%

d. 1.75%

e. 1.56%

Answer 1

Part A)

Yield to Maturity = [Coupon + Pro-rated Discount]/[(Purchase Price + Redemption Price)/2]

Where,

Coupon = $50

Pro Rated Discount = [(Redemption Price-Purchase Price)/Period to Maturity] = [(1000-604.5)/(10)] = $39.55

Redemption Price = 1000

Therefore, YTM = [50+39.55]/[(604.5+1000))/2] = 89.55/802.25 = 0.1116 which is closest to (d) 11%

NOTE: Given Part A and Part B are 2 DIFFERENT QUESTIONS and NOT SUB-QUESTIONS, and as per GUIDELINES, we are supposed to answer ONLY 1 QUESTION.