Question

Five years ago you purchased at face value a newly issued Zurich Insurance Corporation fixed-rate bond with a 5% coupon, paid annually and a six-year maturity. The bond was structured with a put feature which allows you to exercise the option at a strike price of 98 one year before maturity. Currently the one-year yield on short term bonds with similar credit risks are 8% and if you exercised the option you could take the proceeds and invest in the short-term bonds. Explain whether you should exercise the option, I.e, sell the bond back to the company at 98 and invest the money for a year at 8% as opposed to keeping the bond until maturity. Given your decision, explain how you would calculate the effective annual rate of return you would have you earned on your six year investment?

Answer 1

Ans. Calculating the cussent I present price of I boud using calculata di siniply | by using getur cashflow to discount - factor of si... - price 2 100+5 $97.22 1.08 Since spot price * Strike price $98) bond holders must cacersise their sight as investing 998 at 8% wou give them 898* (1.08) a $105.8u Eustead of $105 otherwise. hensidering selling the boud at $98 after s years with 5% annual Doud using Calculata with Future Value $98 Present value $100 years 5 . loupou rate $5 Calculate Ilu a IRR ques IRR 2 4.64%