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Settlement date
14-Feb-99
Model Parameters
CT x C
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CT x P
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A=(CT x C)-1 x CT x P
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Testing CC Function
fr
#VALUE! 1.00278 0.00278 1.00000
#VALUE! 2.00278 0.00278 2.00000
#VALUE! 3.08611 0.08611
#VALUE! 4.16944 0.16944
#VALUE! 5.16944 0.16944
#VALUE! 7.75278 0.25278
#VALUE! ### 0.41944
#VALUE! ### 0.25278
1 2 3
1.0382 0.0082 1.0465
4.1716 0.0903 0.04022 0.01011 4.3122
Term Structure of Interest
Simple yield to maturity based bond valuation models neglect the fact that cash flow patterns may be different between bonds. Compare
the yield to maturity of the two bonds below. Which bond would you select?
Bond A Bond B
Price 114.64 73.64
Coupon 10% 3%
Time to maturity 8 yrs. 8 yrs.
Yield to maturity? 7.50% 7.50%
The table below shows you the zero coupon rates for this market. Based on these data, which bond would you select?
Time (years)
0 1 2 3 4 5 6 7 8
Zero rates 3.746% 5.071% 6.336% 6.862% 7.156% 7.424% 7.493% 7.563% 7.612%
Cash flows
Bond A 10 10 10 10 10 10 10 110
Discounted 114.78 9.5174 8.8438 8.1946 7.5846 6.9903 6.4821 6.0029 61.1656
Price 114.64
Difference - 0.14 negative means bond is "cheap"
Bond B 3 3 3 3 3 3 3 103
Discounted 73.36 2.8552 2.6531 2.4584 2.2754 2.0971 1.9446 1.8009 57.2732
73.64
Difference 0.28 positive means bond is "rich"
If a bond is trading above the present value determined by discounting coupon and principal at the zero coupon rates, we
say the bond is "rich", otherwise it is "cheap".