Grandpa Russ thinks he needs a fixed income for the next 10 years. He currently has $10,000 in CDs which are maturing at the end of this month. The CDs can be renewed for one year at 4½ percent. Russ calls his broker, Ben Seller, and learns that his $10,000 can be put to better use by purchasing debentures issued by Grab-n-Run Inc. These bonds are 10-year bonds with a coupon rate of 8 percent, which is paid semi-annually. The current market interest rate is 6 percent for bonds of a similar nature. The broker tells Grandpa Russ that he may buy each bond for $1,400. Grandpa knows that he will have to pay a premium, but he believes that a $400 premium is too high.
a. What is the maximum price you would tell Grandpa to pay for each bond?
b. Compare the risk of the CD with the risk of the bond.
c. What else would you advise Grandpa with regard to this type of investment?