Consider a bond issued by MGM Inc. exactly two years ago. At that time the bond’s time to maturity was 30 years. The bond pays semiannual coupons with a coupon rate of 6% per year. The face value of the bond is $1000.

1. What is the bond’s price today, if today’s market interest rate for bonds of comparable maturity and default risk is 8% per year? 
2. You would like to speculate and believe that tomorrow the market interest rate for comparable bonds would decrease to 5%, would you buy or sell short this bond today? 
3. Suppose that exactly two years from today the price of the bond will be $900, what is the annual YTM at that time? 

Answer rating: 100% (QA)

All amounts in Part a We are given F Maturity 1000 A Semiannual coupon payment 1000 6 2 30 n Time 302 28 years 56 semiannual periods i Rate of interest 8 pa 4 per semiannual period Now Bond price today P Present value of all future cash inflows P APA i n FPF i n P 30PA 4 56 1000PF 4 56 I used pv4 56 1 and pv4 56 0 1 respectively in excel to find the factor value used below You can alternatively use the tabulated factors too P 302221981910000111207 P 77780157 Bond price today 77780 Answer rounded to the nearest cent Part b Following the same method as illustrated above if we replace the i from 4 per semiannual period to 25 ie 5 2 per semiannual period the present value of all future cash flows turns out to be 114982 If the said bond is available today for 77780 considering your speculation of the interest rate reducing to 5 it will be a good deal to buy the bond for 77780 today and sell the same in the future at a higher price because a reduced interest rate of 5 will make the bond more attractive in future You should buy the bond today Part c n Time 30 ... View the full answer