1. To help financing its green projects, a UK based company is issuing a number of new bonds. These bonds have a face value of £1,000, 10% coupon rate and 5-year maturity. Assume that you can borrow from the risk-free market at the rate of 3% and that the current short rate is 5% but it is expected to be 4%, 5%, and 6% with probability 0.3, 0.4 and 0.3, respectively. Compute possible values of the bonds. Also, compute possible values of the bonds if they are inflation protected. Assume that inflation rate is 1% a year.

1. To help financing its green projects, a UK based company is issuing a number of new bonds. These bonds have a face value of £1,000, 10% coupon rate and 5-year maturity. Assume that you can borrow from the risk-free market at the rate of 3% and that the current short rate is 5% but it is expected to be 4%, 5%, and 6% with probability 0.3, 0.4 and 0.3, respectively. Compute possible values of the bonds. Also, compute possible values of the bonds if they are inflation protected. Assume that inflation rate is 1% a year.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Suppose that we expect $1 million in 3 months and that we want to invest it for a period of 6 months. We also want to set today the rate at which we can invest this money. It is possible to recreate the same result as a forward rate agreement by taking a long position in a 3-month zero-coupon bond and a short position in a 9-month zero-coupon bond True Faux
Suppose you have an obligation to pay € 56 000 in 8 years time. To avoid interest risk you intend to hedge with two bonds. You can use one zero coupon bond that matures 10 years from now, and one bond that pays coupons once a year at the rate of 5% and matures in 3 years with a face value of 100. Assume a flat yield curve. (a) What amount do you have to invest in each of the two bonds during the first year to hedge your obligation if the yield is 5%? What is the payoff at maturity (face value) of your investment in the zero coupon bond? How many units of the coupon bond do you have to buy? (Assume that you can buy any fractional amount of the bonds.) (b) What is the value of your portfolio today if immediately after the investment the market rate falls to 4%? What will be the value in 8 years if interest rates will not change again?
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