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Sep2013 q17

D

dimitris13

Member
Why the extendable bond is likely to have a lower value to investor that the standard bond? ibthink the price is sth like this
Price of bond with option= standard bond + option

also
why if the rates are high the issuer will exercise the option ? From one point i understand that the discouning of a “new” bond would lower the price but at the same time cpn would be higher.
 
The option to extend is with the issuer not the investor, so it is an option "against" the investor. If rates are higher the issuer will extend the bond, and if rates are lower the issuer will repay and issue a new one. A bond with an option against will have a lower price.
 
Hi
In this ques,why have they considered 3 coupon payments and how have the discount factors being calculated?
Please explain.
The disc factors are 1.01,1.0402,1.0715.
Thanks in advance!
 
Hi Nimisha

The valuation date of the bond is 30/10/13, the bond's redemption date is 31/12/14 and the bond pays coupons twice a year, so there are three coupons remaining, paid on the following dates: 31/12/13, 30/6/14, 31/12/14

I think the examiners have used exact days to calculate the discount factors (noting that the second discount factor they used is actually 1.0403)

The GRY is 6% pa. So, as it a bond that pays coupons twice a year, this will be an annual rate compounding twice a year or half-yearly.

So it's probably easiest to do our discount rate calcs using 3% and working in six monthly periods.

Assume there are 184 days in a six month period

So, the payment on 31/12/14 is about 62 days away. So the discount factor is 1.03^(62/184) = 1.0100

The good news is the examiners accepted other day count conventions or answers that used months eg for the first payment 1.03^(2/6)
 
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