INV2601 Assignment 02 Semester 01 2022 Answers

INVESMENTS: AN INTRODUCTION
INV2601

SEMESTER 1 2022
ASSIGNMENT 02 SOLUTIONS

, Question 1


Which bond risk exposure entails the possibility that the issuer will fail to meet its obligations
regarding the timely payment of coupons and principal?
a. Credit spread risk
b. Default risk
c. Downgrade risk
d. Interest risk
Credit risk comprises default risk, credit spread risk and downgrade risk.

• Default risk - is defined as the possibility that the issuer will fail to meet its obligations
regarding the payments of coupons and the eventual principal in a timely manner.
• Credit spread risk - A credit spread is the difference in the yield between different
bonds due to their different credit quality. The credit spread reflects the additional net
yield an investor can earn from a less credit risk. Reflects the extra compensation
investors receive from bearing credit risk. Credit spread risk is measured by the size of
the yield differential (risk premium or spread) of a particular bond above a default-free
government bond. –
• Downgrade risk - is the risk that a bond’s price will decline due to a downgrade in its
credit rating. Downgrade risk arises from the deteriorating financial condition of a
company and is a risk every bond faces to a certain extent.




Question 2
A zero-coupon bond has a par value of R1 000 with a maturity of 20 years and a yield to
maturity of 8% compounded semi-annually. Calculate the present value of the bond.

a. R214.55
b. R208.29
c. R456.39
d. R1000



FV = 1000; N = 40(20x2); I/YR = 4(8/2); PMT =0 CPT PV = 208.29