Case Study 2 (Bond Calculation)

An investor is planning to invest in the bond market and has the following choices:

Bond A:

This is a coupon bond from ABM Ltd. The bond has a face value of $1,000 and a coupon rate of 5% paid semi-annually.The bond matures in 8 years.

Bond B:

This is a zero-coupon bond from ABM Ltd. The bond has a face value of $1,000. Interest on this bond compounds semi-annually.The bond matures in 8 years.

The market rate of interest for both bonds is 4%.

Considering the above information, please answer the following:

(a) Determine the value of both bonds.

(b) For both bonds, state if they sell at par or premium or discount.

(please note what is meant by par/premium/discount bonds. Then, considering the price determined or the other given information, please just state, for each of the bonds, whether the bond sells at par or premium or discount.)

(c) Suppose the investor buys a zero-coupon bond of ABM Ltd. for the price (i.e., value) determined in

(a) and then sells the bond for $710 after 4 years. Determine the realised yield for the investor.

( The price determined in (a) provides one of the information needed; the other information is given in the question.)