Hi guys,
This is a question from Schweser Vol2 Exam 2 PM. Q# 218.
A 10 year 5% bond is issued at a price to yield 5.2%. Three months after issuance, market rates for 10 year Treasuries decline by 100 basis points. The most likely price of this bond at issuance and 3 months later is:
A. above par at issuance, but below par three months later
B. below par at issuance, but below par three months later
C. below par at issuance, and below par three months later
I got the first part. But I thought the price would still be below par as a 100 basis point drop in the 10 year treasuries would be reflected in a ~100 basis point drop in the YTM of the bond (also 10 year maturity) dropping it to ~5.1% and keeping it a discount bond, hence answer C.
But, the correct answer is B stating with regard to the second part the following: “…Three months later, when market yields have declined, the 5% coupon will be more attractive, and the bond will trade at a premium to par, reflecting the fact that the coupon is now higher than the yield available on comparable bonds.”
What am I missing? Can anyone help? Thanks!作者: MonkeyBusiness 时间: 2013-4-3 06:24
a 100 basis point drop is 1%, dropping the yield to approx 4.2% thus increasing the price above par (typo in your answer options)作者: scruge 时间: 2013-4-3 06:29
Treasuries interest rate declined to 4.2%, thus the price of the bond went up.
Example 10% bond with face value of $909. If interest rate goes down to 5% the face value must be $952. Thus increase of $50 in face value due to lower interest rate
By the why, answer B is typed incorrectly it should read: below par at issuance, but above par three months later.作者: brk1yn 时间: 2013-4-3 06:34
Question is vague, where does it say that the bond in question is a treasury? It just says that it’s a bond, and that 3 months down the line, treasury yields decrease.
You would have to know the actual treasury yield versus the bond coupon to determine if it’s a discount or premium, so assuming that they are referring to 4.2% (5.2% 100 bps drop) as the treasury rate, yes, coupon>yield = premium in 3 months.作者: cyber21 时间: 2013-4-3 06:40
Daaah! Thanks guys! It’s the 4:30AM effect! I was thinking about it this morning while taking a shower (I know, it’s pretty sad indeed!) and it hit me! I do at least 34 stupid mistakes like this one on every mock I take and then bang my head afterward cause it prevents me from crossing the 80% mark.
