INV3702 ASSIGNMENT 2
2024|QUESTIONS AND
CORRECT ANSWERS
100% PASS
QUESTION 1
Determine whether
Bond E is overvalued,
undervalued or fairly
valued. All coupons
are paid annually.
, The price of the 3-year coupon bond (as a percent of par) is:
N = 3; I/YR = 2.711; PMT = 5; FV = 100;
Compute PV = –106.51
The no-arbitrage price of the 3-year coupon bond based on spot (zero-coupon) rates is:
5 5 105
+ + = 106.51
1.02350 (1.02500)2 1.027253
Therefore the 3-year coupon bond's price equals its no-arbitrage value, therefore the bond
is fairly valued.
QUESTION 2
Explain to Kgomotso why her method leads to an incorrect answer, and advise her on the
correct method to approach this question. No calculations are necessary.
Kgomotso’s method uses the yield-to-maturity as the input for I/YR.
Yield-to-maturity is not appropriate for arbitrage-free valuation when the yield curve is not
flat.
She should value each cash flow separately using the corresponding spot rate.
5
105
Full marks for the correct equation: +
1.035 1.03652
2024|QUESTIONS AND
CORRECT ANSWERS
100% PASS
QUESTION 1
Determine whether
Bond E is overvalued,
undervalued or fairly
valued. All coupons
are paid annually.
, The price of the 3-year coupon bond (as a percent of par) is:
N = 3; I/YR = 2.711; PMT = 5; FV = 100;
Compute PV = –106.51
The no-arbitrage price of the 3-year coupon bond based on spot (zero-coupon) rates is:
5 5 105
+ + = 106.51
1.02350 (1.02500)2 1.027253
Therefore the 3-year coupon bond's price equals its no-arbitrage value, therefore the bond
is fairly valued.
QUESTION 2
Explain to Kgomotso why her method leads to an incorrect answer, and advise her on the
correct method to approach this question. No calculations are necessary.
Kgomotso’s method uses the yield-to-maturity as the input for I/YR.
Yield-to-maturity is not appropriate for arbitrage-free valuation when the yield curve is not
flat.
She should value each cash flow separately using the corresponding spot rate.
5
105
Full marks for the correct equation: +
1.035 1.03652
