INV3702 Assignment 2 (COMPLETE ANSWERS) Semester 1 2025 – DUE April 2025;100% CORRECT AND TRUSTED SOLUTIONS

,INV3702 Assignment 2 (COMPLETE ANSWERS) Semester 1 2025
– DUE April 2025;100% CORRECT AND TRUSTED SOLUTIONS

Question 1
You observe the following sovereign bonds.
Time to maturity Coupon Yield to maturity
Bond A 1 year 6% 2.342%
Bond B 1 year 0% 2.350%
Bond C 2 years 6% 2.496%
Bond D 2 years 0% 2.500%
Bond E 3 years 6% 2.711%
Bond F 3 years 0% 2.725%
Determine whether Bond C is overvalued, undervalued or fairly valued. All
coupons are paid annually. (3)


Step 1: Understand the Problem
You are given:

 Bond C: 2-year bond, 6% coupon, YTM = 2.496%
 All coupons are annual.

We are tasked with valuing Bond C based on the zero-coupon yield
curve (which we can infer from the given data for 1-year and 2-year
zero-coupon bonds) and then comparing this value to the value implied
by its yield to maturity (YTM).



📝 Step 2: Gather and Interpret Given
Information
The important data:

, Time to Maturity Coupon Yield to Maturity
Bond
A 1 year 6% 2.342%
B 1 year 0% 2.350%
C 2 years 6% 2.496%
D 2 years 0% 2.500%
E 3 years 6% 2.711%
F 3 years 0% 2.725%

Zero-coupon bond yields:

 1-year zero (Bond B): 2.350%
 2-year zero (Bond D): 2.500%
 3-year zero (Bond F): 2.725%

Thus, the zero-coupon yield curve is:

 Year 1: 2.350%
 Year 2: 2.500%
 Year 3: 2.725%



📝 Step 3: Calculate the Theoretical Price of Bond C Using the Zero-
Coupon Yields

Bond C is a 2-year, 6% coupon bond.

 It pays 6% of face value per year.
 Assume face value = 100 (standard assumption unless otherwise
stated).

Thus, cash flows are:

 Year 1: Coupon = 6
 Year 2: Coupon + Principal = 6 + 100 = 106