Chapter 11, Problem 9CP

Summary Introduction

(a)

To Discuss:

You are the manager for the bond portfolio of a pension fund. The policies of the fund allow for the use of active strategies in managing the bond portfolio. It appears that the economic cycle is beginning to mature, inflation is expected to accelerate and in an effort to contain the economic expansion, the central bank is moving toward tighter monetary policy. For each of the situations below, state which one of the two bonds you would prefer. Briefly justify your answer in each case.

1. Government of Canada (Canadian Pay),4% due in 2022,and priced at 101.25 to yield 3.5% to maturity;
Or

Government of Canada (Canadian Pay),4% due in 2032,and priced at 95.75 to yield

4.19 % to maturity.

Introduction:

A bond is a security that creates an obligation on the issuer to make specified payments to the holder for a given period of time. The face value of the bond is the amount the holder will receive on maturity along with the coupon rate which is also known as the interest rate of the bond.A zero-coupon bond is a bond where the face value is repaid at the time of maturity.Yield to maturity is defined as the discount rate that makes the present payments from the bond equal to its price, in simple terms it is the average rate of return a holder can expect from that bond.