Bond Valuation

Assignment for Week -2
Chapter 5
(5 - 9) Bond Valuation and Interest Rate Risk
Bond L Bond S
INS = $100 INS = $100
M = $1,000 M = $1,000
N = 15 Years N = 1 Year
a)
1) rd = 5%
VBL = INT/ (1 + rd)t + M/ (1 + rd)N =INT [1/rd – 1/ rd(1 + rd)N ] + M/ (1 + rd)N =$100 [1/0.05 – 1/ 0.05(1 + 0.05)15] + $1,000/ (1 + 0.05)15 =$1040 + $480.77 = $1518.98
VBS = INT/ (1 + rd)t + M/ (1 + rd)N =$100 [1/0.05 – 1/ 0.05(1 + 0.05)1] + $1,000/ (1 + 0.05)1 = $95 + $952.381 = $ 1,047.381
2) rd = 8%
VBL = INT/ (1 + rd)t + M/ (1 + rd)N =$100 [1/0.08 – 1/ 0.08(1 + 0.08)15] + $1,000/ (1 + 0.08)15 = $856 + $315.19 = $1171.19
VBS = INT/ (1 + rd)t + M/ (1 + rd)N =$100 [1/0.08 – 1/ 0.08(1 + 0.08)1] + $1,000/ (1 + 0.08)1 = $92.6 + $925.92 = $1018.52
3) rd = 12%
VBL = INT/ (1 + rd)t + M/ (1 + rd)N =$100 [1/0.12 – 1/ 0.12(1 + 0.12)15] + $1,000/ (1 + 0.12)15 =$681 + $182.78 =$863.78
VBS = INT/ (1 + rd)t + M/ (1 + rd)N =$100 [1/0.12 – 1/ 0.12(1 + 0.12)1] + $1,000/ (1 + 0.12)1 =$893 + $892.84 =$982.14
b) This is because of once the bond has been on the market for quite some time, it is considered to be an outstanding bond and an increase in interest rates will cause the price of such outstanding bond to fluctuate more and fall and then cause it to vary widely from par. Whereas, for shorter-term bonds, they are generally sell very close to par and such short-term bonds usually actively traded and regardless of the rise of interest rate, they sell very close to par.
Chapter - 6
(6 – 4) Expected Return: Discrete Distribution
 Expected Rate of Return = ^r = P1r1 + P2r2 + …. Pn rn n