On 1 October 2016, you are reviewing two fixed-rate bonds issued by a local firm, the two
Question:
On 1 October 2016, you are reviewing two fixed-rate bonds issued by a local firm, the two bonds, whose characteristics are given in the table below:
Bond | Maturity | Coupon | Type of Bond |
Bond A | 1 October 2019 | 6% annual | Callable at par on 1 October 2017 and on 1 October 2018 |
Bond B | 1 October 2019 | 6% annual | Putable at par on 1 October 2017 and on 1 October 2018 |
Based on an estimated interest rate volatility of 20%, you constructed the binomial annual interest rate tree shown below.
0.035 | 0.06815 | 0.1183 |
0.04285 | 0.07932 | |
0.05317 |
1) Calculate the value of Bond A and Bond B.
2) Which bond would most likely protect investors against a significant increase in interest rates?
3) All else being equal if you assume an interest rate volatility of 15% instead of 20%, the bond that would most likely increase in value is:
