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Essential of investments - Assignment Example

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The flat price was calculated by using the PRICE function in excel with the settlement date being 22-Feb-2012, maturity date being 15-Mar-2020, coupon rate being 5.50%, YTM being 5.34%, redemption value being $100 and 2 coupon payments per year. Hence, the flat or the list price…
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Essential of investments
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Download file to see previous pages The accrued interest on the bond turned out to be $2.42.
The YTMs were calculated using the YIELD function on excel, with settlement date and maturity date taken at a difference of 10 years, coupon rate being 14% and then reduced to half at 7%, the bond price being $900, redemption value being $1000, and 1 coupon annually. The YTM based on what the firm promised is 2.55%. However, based on what the investors expect after the lenders and the firm agreed to lower the payments the YTM became 1.80%. The expected YTM is lower than the YTM investors were actually promised.
a. The initial price is calculated as P=$705.46, with [n=20, I/Y=8, PMT=50, FV=1000]. The price in the next period would be P=$793.29, with [n=19, I/Y=7, PMT=50, FV=1000]. Therefore the HPR is 19.53% calculated as, [{50+(793.29-705.46)}/705.46]
c. The 6% coupon bond performed better than the zero coupon bond in either case, when the interest rose or when they fell. This is probably due to the fact that the 6% coupon bond has a higher convexity. This shows that whenever we compare the change in yields of bonds by equal amounts as is in this question, the bond with higher convexity will always outperform the one with lower convexity. The duration was approximately equal but the convexity of both the bonds were different in this example which is always positive implies that the convexity effect always favors the higher convexity bond.
d. Such a scenario where the bonds would be priced at the same yield to maturity if the rates changed in equal amounts cannot exist. No investor would buy a bond with a lower convexity as it always underperform the higher convexity bond. The price of the lower convexity bond will be low with a high YTM, which means that the higher yield is to compensate the investor for investing in a lower convextiy bond.
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