Look one more time at Table 3.5. a. Suppose you knew the bond prices but not the
Question:
Look one more time at Table 3.5.
a. Suppose you knew the bond prices but not the spot interest rates. Explain how you would calculate the spot rates.
b. Suppose that you could buy bond C in large quantities at $1,040 rather than at its equilibrium price of $1,076.20. Show how you could make a zillion dollars without taking on any risk.
TABLE 3.5
Year (t) Bond Price (PV) Yield to Maturity (y,%) 4 Spot rates 0.03 0.04 0.05 0.06 Discount factors 0.9709 0.9246 0.8638 0.7921 Bond A (8% coupon) Payment (C) $80.00 1,080.00 PV (C) 77.67 998.52 $1,076.19 3.96 Bond B (8% coupon) Payment (C) $80.00 80.0 1,080.00 $77.67 7396 932.94 PV (C) $1,084.58 4.90 Bond C (8% coupon) Payment (C) 0.00 80.00 80.00 1,080.00 $77.67 73.96 PV (C) 69.11 855.46 $1,076.20 5.81
Step by Step Answer:
a We can set up the following three equations using the prices of bonds A B and C Using bond A 10761...View the full answer
Principles of Corporate Finance
ISBN: 978-1259144387
12th edition
Authors: Richard Brealey, Stewart Myers, Franklin Allen
Related Video
The present value of future cash flows is calculated to determine the value today of a stream of future cash flows. It is calculated by discounting the future cash flows to their present value using a discount rate. The discount rate reflects the time value of money and the risk of the cash flows. It is important because it helps in making investment decisions, capital budgeting, loan decision making, and financial planning. By discounting future cash flows to their present value using a discount rate, it takes into account the time value of money and the risk associated with the cash flows. This allows investors, lenders, and financial planners to evaluate the viability of potential investments, projects, or loan applications, and to estimate the future value of investments or savings. calculating the present value of future cash flows is important in making investment decisions, capital budgeting, loan decision making, and financial planning. It helps to determine the viability of long-term projects, evaluate loan applications, and estimate the future value of investments or savings.
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