Problem 1: Bond Valuation and duration

Question a
The coupon payment can be found by multiplying the coupon rate with the par
value:
C = rc P arV alue
Using this formula we find following coupon payments for our bonds: CA = 9,
CB = 27 and CC = 0. We can than calculate the current yield with the formula.
rCY = C/P
with P the current price. We find as current yield for our bonds: rCY,A = 0.00989,
rCY,B = 0.02727 and rCY,C = 0
Question b
The yield to maturity rY T M can be found be solving following equation to rY T M :


P = C/rY T M 1 (1 + rY T M )T + P arV alue (1 + rY T M )T
This way, we find for the yield to maturity: RY T M,A = 0.00836, RY T M,B = 0.01485
and RY T M,C = 0.07598.
Question c
The duration is the weighted average of the maturities of a bonds cash flows and
so can be calculated by the formula:
D=

T
X
t=1

X
C
1
1
P arV alue 1
CFt
t

+
T

t
T
(1 + i)t P
(1
+
i)
P
(1
+
i)
P
t=1

We find for the durations: DA = 6.797, DB = 6.449 and DC = 6.000. The duration
is inversely related to the coupon rate and the interest rate (Yield to maturity)
and directly related the maturity (the yield to maturity is all bonds smaller than
the coupon rate). Because the bonds have different coupon rates, interest rates
and maturities, they will also have different durations.
Question d
Looking at the default risks of the three countries, we can say the following: Greece
will have a much greater default risk as Belgium and Belgium will have a slightly
greater default risk as Germany. A higher default risk will mean that the yield
curve will lie higher. This means a higher yield to maturity for the same maturity.
We see that bond C has a very high yield to maturity, despite a lower maturity.
We can clearly identify this bond as Greece. Now the two other bonds have the
same maturity, but bond B has a higher yield to maturity than bond A. We can
finally conclude that bond B will be Belgium and bond A will be Germany.
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