S998AMQ2.1

1. Use this STRIP table to price a 5% coupon bond with semi-annual coupons and one year to maturity. The next coupon is due in October 1999. (2pts.)

First figure out the cash flows from the bond. A 5% coupon bond pays 5% of its par value (assumed to be $1000 when it’s not mentioned) every year. The semi-annual payments mean that the $50 is split-up and paid in $25 installments every 6 months. Thus, the cash flows are:

Oct 99	April 2000
25	1025

The STRIP table tells us that we can get $100 in Oct 99 for $97 8/32 ($97.25) today, which means that the value today of $1 in Oct99 is $0.9725. Therefore, the $25 we're going to get in Oct 99 is worth $25(0.9725)=$24.3125 today. $100 in April 2000 is selling for $94 24/32 ($94.75) today. Thus, the $1025 we will receive in April 2000 is worth $1025(0.9475)=$971.1875 today. The total value of the cash flows of the bond is the bond's price: $24.3125+$971.1875=$995.50.

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