A corporation has an obligation to pay 100, 000 at the end of two years and another 100, 000 at the end of three years. There are two bonds available to buy and try to match these liabilities. The first bond is a two-year bond with annual coupons at rate 20%, and the second bond is a three-year bondwith annual coupons at 40%. The yield rates on both bonds and reinvestment rates for each of thenext three years are all at an annual effective rate of 25%. The corporation purchases α face amountof the two-year bond and β face amount of the three-year bond. The coupon received at time oneis reinvested, and any excess of bond payment over 100, 000 at time 2 is reinvested. The reinvestedamount along with the bond payments at time three are exactly enough to pay the 100, 000 due attime three. Find the minimum value of α that will guarantee that the asset cashflow available at time two is at least 100, 000. Show your work.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Question

A corporation has an obligation to pay 100, 000 at the end of two years and another 100, 000 at the end of three years. There are two bonds available to buy and try to match these liabilities. The first bond is a two-year bond with annual coupons at rate 20%, and the second bond is a three-year bond
with annual coupons at 40%. The yield rates on both bonds and reinvestment rates for each of the
next three years are all at an annual effective rate of 25%. The corporation purchases α face amount
of the two-year bond and β face amount of the three-year bond. The coupon received at time one
is reinvested, and any excess of bond payment over 100, 000 at time 2 is reinvested. The reinvested
amount along with the bond payments at time three are exactly enough to pay the 100, 000 due at
time three. Find the minimum value of α that will guarantee that the asset cashflow available at time two is at least 100, 000. Show your work.

Expert Solution
steps

Step by step

Solved in 2 steps

Blurred answer
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education