Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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Two bonds have the following terms:                            
                                   
Bond A   Bond B                      
Principal $1,000   Principal $1,000                      
Coupon 8%   Coupon 7.6%                      
Maturity 10 years   Maturity 10 years                      
                                   
Bond B has an additional feature: It may be redeemed at par after five years (i.e., it has a put feature) But bonds were initially sold for their face amounts (i.e., $1,000).    
                                   
A. If interest rates fall to 7 percent, what will will be the price of each bond?                    
B. If interest rates rise to 9 percent, what will be the decline in the price of each bond from its intiial price?              
C. Given your answers to questions (a) and (b), what is the trade-off implied by the put option in bond B?              
D. Bond B requires the investor to forgo $4 a year (i.e., $40 if the bond is in existence for ten years). If interest rates are 8 percent, what is the present value of this forgone interest?
  If the bond had lacked the put feature but had a coupon of 7.6 percent and a term to maturity of ten years, it would sell for $973.16 when interest rates were 8 percent.  
  What, then, is the implied cost of the put option?                        
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