Homework 6

1) A corporation has two different bonds currently outstanding. Bond A has a face value of
$30,000 and matures in 20 years. The bond makes no payments for the first six years, then pays
$800 every six months over the subsequent eight years, and finally pays $1,000 every six
months over the last six years. Bond B also has a face value of $30,000 and a maturity of 20
years; it makes no coupon payments over the life of the bond. If the required return on both
these bonds is 8 percent compounded semiannually, what is the current price of Bond A? Of
Bond B?

2) A company wants to issue new 20-year bonds for some much-needed expansion projects.
The company currently has 7 percent coupon bonds on the market that sell for $1,063, make
semiannual payments, and mature in 20 years. What coupon rate should the company set on its
new bonds if it wants them to sell at par?

3) Consider a four-year, default-free security with annual coupon payments and a face value of
$1000 that is issued at par. What is the coupon rate of this bond?

4) Prices of zero-coupon, default-free securities with face values of $1000 are summarized in
the following table:

Maturity (years) 1 2 3
Price (per $1000 face value) $970. 87 $938. 95 $904. 56

Suppose you observe that a three-year, default-free security with an annual coupon rate of 10%
and a face value of $1000 has a price today of $1183. 50. Is there an arbitrage opportunity? If
so, show specifically how you would take advantage of this opportunity. If not, why not?

5) Exercise Slide 9 Bonds (C4 2-2)

6) Exercise Slide 22 Bonds (C4 2-2). Suppose the yield (APR) decreases by 1. 75% . Compare
the exact percentage change in the price of the bond with the duration approximation.