W00Q2.1

1.Use this STRIP table to price a 7% coupon bond with semi-annual coupons and one and a half years to maturity. The next coupon is due in August 2000 and it is now Feb 2000. (2 pts)

  1. STRIP

    Ask
    May 2000

    98:12
    Aug 2000

    96:30
    Feb 2001

    93:24
    May 2001

    92:04
    Aug 2001

    90:16
    Feb 2002

    87:20

    First convert the description of the bond into a cashflow diagram. 7% coupon means that 7% of par value (remember par is always $1000 unless stated otherwise) is paid out annually. Semi-annual coupons mean that the $70 (=7% of $1000) is paid in 2 equal installments at 6 month intervals. 1.5 years to maturity means that coupon payments continue for 1.5 more years at which point the par value is returned and the bond ceases to exist.

    Feb 2000 August 2000 Feb 2001 August 2001
    0 35 35 1035

    Now we have to value these cashflows. The STRIP table will help us do this. The STRIP table tells us that $100 received in Aug 2000 is worth 96:30 today. The ":30" translates into 30/32=.9375 so that means that $100 in 8/00 is worth $96.9375 today or $1 in 8/00 is worth $0.969375 today. Thus, $35 in 8/00 is worth $35(0.969375)=$33.928 today.

    The STRIP values for the other dates are 93:24 ($93.95) and 90:16 ($90.50). Following the same procedure, we get values of $32.8125 and $936.765 for the last 2 cashflows.

    The total present value of the package of cashflows (and, thus, the price of the bond) is $33.928+32.8125+936.675=$1003.42

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