Question: A portfolio manager is considering buying two bonds. Bond A matures in three years and has a coupon rate of 10% payable semiannually. Bond B,

A manager is considering buying two bonds. Bond A matures in three years and has a rate of 10% payable semiannually. Bond B, of the same credit quality, matures in 10 years and has a rate of 12% payable semiannually. Both bonds are priced at par.
(a) Suppose that the manager plans to hold the bond that is purchased for three years. Which would be the best bond for the manager to purchase?
(b) Suppose that the manager plans to hold the bond that is purchased for six years instead of three years. In this case, which would be the best bond for the manager to purchase?
(c) Suppose that the manager is managing the assets of a life insurance company that has issued a five-year guaranteed investment contract (GIC). The interest rate that the life insurance company has agreed to pay is 9% on a semiannual basis. Which of the two bonds should the manager purchase to ensure that the GIC payments will be satisfied and that a profit will be generated by the life insurance company?

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a The shorter term bond will pay a lower coupon rate but it will likely cost less for a given market rate Since the bonds are of equal risk in terms of credit quality the maturity premium for the long... View full answer

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