Suppose that you purchase a 4-year $700 annual coupon bond with a coupon rate of 5%. Assume that market interest rate (discount rate) is 4% and remains the same for the 4 years. Consider two investment strategies: 1. Hold the bond until maturity 2. Hold the bond for two years, collect two coupon payments and then sell the bond at the market price. Show that the two strategies have the same present value. Hint: to compute the market price of the bond during the second year, compute the present value of the remaining cash flows at the moment of sale
Suppose that you purchase a 4-year $700 annual coupon bond with a coupon rate of 5%. Assume that market interest rate (discount rate) is 4% and remains the same for the 4 years. Consider two investment strategies: 1. Hold the bond until maturity 2. Hold the bond for two years, collect two coupon payments and then sell the bond at the market price. Show that the two strategies have the same present value. Hint: to compute the market price of the bond during the second year, compute the present value of the remaining cash flows at the moment of sale
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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Please provide a detailed explanation and calculation
Transcribed Image Text:### Bond Investment Strategies: A Comparative Analysis
#### Scenario:
Suppose that you purchase a 4-year $700 annual coupon bond with a coupon rate of 5%. Assume that the market interest rate (discount rate) is 4% and remains the same for the 4 years. Consider two investment strategies:
1. **Hold the bond until maturity**
2. **Hold the bond for two years, collect two coupon payments, and then sell the bond at the market price**
### Objective:
Show that the two strategies have the same present value.
#### Hint:
To compute the market price of the bond during the second year, compute the present value of the remaining cash flows at the moment of sale.
### Steps to Solution:
1. **Calculate the present value of holding the bond until maturity.**
2. **Calculate the present value of holding the bond for two years and selling it.**
**Note:** The calculations will involve discounting future cash flows using the market interest rate to determine the present value.
This analysis will help in understanding the concept of bond valuation and present value, providing a practical example of investment decision-making in the bond market.
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