f interest rates fall to 7 percent, what will will be the price of each bond? B. If interest rates rise to 9 percent, what will be the decline in the price of each bond from its intiial price? C. Given your answers to questions (a) and (b), what is the trade-off implied by the put option in bond B?
f interest rates fall to 7 percent, what will will be the price of each bond? B. If interest rates rise to 9 percent, what will be the decline in the price of each bond from its intiial price? C. Given your answers to questions (a) and (b), what is the trade-off implied by the put option in bond B?
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
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Question
| Two bonds have the following terms: | |||||||||||||||||
| Bond A | Bond B | ||||||||||||||||
| Principal | $1,000 | Principal | $1,000 | ||||||||||||||
| Coupon | 8% | Coupon | 7.6% | ||||||||||||||
| Maturity | 10 years | Maturity | 10 years | ||||||||||||||
| Bond B has an additional feature: It may be redeemed at par after five years (i.e., it has a put feature) But bonds were initially sold for their face amounts (i.e., $1,000). | |||||||||||||||||
| A. | If interest rates fall to 7 percent, what will will be the price of each bond? | ||||||||||||||||
| B. | If interest rates rise to 9 percent, what will be the decline in the price of each bond from its intiial price? | ||||||||||||||||
| C. | Given your answers to questions (a) and (b), what is the trade-off implied by the put option in bond B? | ||||||||||||||||
| D. | Bond B requires the investor to forgo $4 a year (i.e., $40 if the bond is in existence for ten years). If interest rates are 8 percent, what is the present value of this forgone interest? | ||||||||||||||||
| If the bond had lacked the put feature but had a coupon of 7.6 percent and a term to maturity of ten years, it would sell for $973.16 when interest rates were 8 percent. | |||||||||||||||||
| What, then, is the implied cost of the put option? |
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