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    Bond values and interest rates

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    Suppose that 5-year government bonds are selling on a yield of 4 percent. Value a 5-year bond with a 6 percent coupon. Start by assuming that the bond is issued by a continental European government and makes annual coupon payments. Then rework your answer assuming that the bond is issued by the U.S. Treasury, so that the bond pays semiannual coupons and the yield refers to a semiannually compounded rate.

    How would the bond value in each case change if interest rates fall to 3 percent?

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    Solution Preview

    Please see attached file
    Suppose that 5-year government bonds are selling on a yield of 4 percent. Value a 5-year bond with a 6 percent coupon. Start by assuming that the bond is issued by a continental European government and makes annual coupon payments. Then rework your answer assuming that the bond is issued by the U.S. Treasury, so that the bond pays semiannual coupons and the yield refers to a semiannually compounded rate.

    Calculating Price of bond
    To calculate the price of the bond we need to calculate / read from tables the values of
    PVIF= Present Value Interest Factor
    PVIFA= Present Value Interest Factor for an Annuity
    Price of bond= PVIF * Redemption value + PVIFA * interest payment per period

    PVIFA( n, r%)= =[1-1/(1+r%)^n]/r%
    PVIF( n, r%)= =1/(1+r%)^n

    Yield= 4%

    1) Annual Coupon Payments

    Data
    No of years to maturity= 5
    Coupon rate= 6.00%
    Face value= $1,000
    Frequency = A Annual Coupon payments
    Discount rate annually= 4.00% (Yield to maturity)
    Redemption value = Face ...

    Solution Summary

    Calculates bond values for annual and semi annual compounding for different interest rates.

    $2.19

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