Aires and Huma, buddies since childhood, both have just had their first child. To finance their...
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Aires and Huma, buddies since childhood, both have just had their first child. To finance their kids' tertiary education, they have each just invested in an 18-year (fixed) coupon bond. The bond has a face value of $1,000 and pays 6% (APR) semi-annual coupons. Given the market condition at the time of purchase, Huma and Aires purchased the bond at par. Before finalizing their purchase decisions, they tried to seek answers to the following questions that they believed would address their potential concerns about the investment. (a) Given the cash flows and risk of the bond in question, how much did Aires/Huma pay to buy the bond? Briefly explain. (3 marks) (b) If Huma and Aires hold the bonds until maturity, what is the average yearly (total) rate of return (APR) if the interest rate remains unchanged for the bond? Briefly explain. [Hint: Instead of thinking about the calculations, focus on what is being asked here.] (3 marks) (c) Aires has been contemplating the possibility that he may need to sell some units of the bond after one year of holding. Based on his (and Huma's) analysis, the relevant discount rate of the bond may have risen by 2 percent one year from now (and stay at that level until the bond's maturity). Should that happen, Aires and Huma would like answers to their investment returns: i) current yield and capital gains yield (for one year) for Aires [6 marks] ii) holding period yield (for one year) for Aires, assuming coupons received in first year can be re-invested at the interest rate of 6% (APR) with semi-annually compounding iii) If the interest rate does go up by 2 percent, will Huma's (education) financing plan be affected? If yes, positively or negatively? Briefly explain. [2 marks] (11 marks) Aires and Huma, buddies since childhood, both have just had their first child. To finance their kids' tertiary education, they have each just invested in an 18-year (fixed) coupon bond. The bond has a face value of $1,000 and pays 6% (APR) semi-annual coupons. Given the market condition at the time of purchase, Huma and Aires purchased the bond at par. Before finalizing their purchase decisions, they tried to seek answers to the following questions that they believed would address their potential concerns about the investment. (a) Given the cash flows and risk of the bond in question, how much did Aires/Huma pay to buy the bond? Briefly explain. (3 marks) (b) If Huma and Aires hold the bonds until maturity, what is the average yearly (total) rate of return (APR) if the interest rate remains unchanged for the bond? Briefly explain. [Hint: Instead of thinking about the calculations, focus on what is being asked here.] (3 marks) (c) Aires has been contemplating the possibility that he may need to sell some units of the bond after one year of holding. Based on his (and Huma's) analysis, the relevant discount rate of the bond may have risen by 2 percent one year from now (and stay at that level until the bond's maturity). Should that happen, Aires and Huma would like answers to their investment returns: i) current yield and capital gains yield (for one year) for Aires [6 marks] ii) holding period yield (for one year) for Aires, assuming coupons received in first year can be re-invested at the interest rate of 6% (APR) with semi-annually compounding iii) If the interest rate does go up by 2 percent, will Huma's (education) financing plan be affected? If yes, positively or negatively? Briefly explain. [2 marks] (11 marks)
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Answer rating: 100% (QA)
a The price of the bond was determined based on the present value of the future cash flows taking into account the risk associated with the bond Since the bond is a fixedcoupon bond with a known coupo... View the full answer
Related Book For
Fundamentals Of Corporate Finance
ISBN: 9780135811603
5th Edition
Authors: Jonathan Berk, Peter DeMarzo, Jarrad Harford
Posted Date:
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