ACST201 Financial Modelling: Bond Valuation Quiz Solution S2 2019

This document provides a detailed solution to a bond valuation quiz, focusing on financial modelling concepts. It includes calculations for the price of zero-coupon bonds (Instrument A) and treasury bonds (Instruments B and C) under specific yield rates. The solution further elaborates on determining the duration of these bonds and a portfolio composed of them, along with an explanation of the duration matching principle to mitigate interest rate risk. Additionally, the document calculates the sale price and holding period return for Bond B, and incorporates the probability of default in pricing a corporate bond. The document includes calculations and explanations, offering a comprehensive guide to bond valuation techniques. Desklib provides access to a wide array of solved assignments and past papers for students.

Running head: BOND VALUATION
Bond Valuation
Name of the Student:
Name of the University:
Author Note:

1BOND VALUATION
Table of Contents
Answer to Question 1:................................................................................................................2
Part a:.....................................................................................................................................2
Part (i):...............................................................................................................................2
Part (ii):..............................................................................................................................2
Part (iii):.............................................................................................................................2
Part b:.....................................................................................................................................3
Part (i):...............................................................................................................................3
Part (ii):..............................................................................................................................4
Part (iii):.............................................................................................................................4
Part c:.....................................................................................................................................4
Part (i):...............................................................................................................................4
Part (ii):..............................................................................................................................5
Part d:.....................................................................................................................................5
Part (i):...............................................................................................................................5
Part (ii):..............................................................................................................................5
Part e:.....................................................................................................................................6
References and Bibliographies:..................................................................................................7

2BOND VALUATION
Answer to Question 1:
Part a:
Part (i):
The price of Bond A is $71.11and is calculated in the figure below,
Figure 1: Bond A
Source: By the Author
Part (ii):
The price of Bond B is $99.68 and is calculated in the figure below,
Figure 2: Bond B
Source: By the Author
Part (iii):
The price of Bond C is $99.37 and is calculated using the RBA method and is given below,

3BOND VALUATION
Figure 3: Bond C
Source: By the Author
Part b:
Part (i):
The Duration of Bond A is calculated and presented in the table below,
Figure 4: Duration of Bond A

4BOND VALUATION
Source: By the Author
Part (ii):
The duration of bond B is calculated in the figure below,
Figure 5: Duration of Bond B
Source: By the Author
Part (iii):
The change in price of Bond C with the change in yield is highlighted in the table below,
Figure 6: Change in Bond Price
Source: By the Author
Part c:
Part (i):
The Duration of the portfolio is calculated and is shown in the table below,

5BOND VALUATION
Figure 7: Portfolio Duration
Source: By the Author
Part (ii):
The duration matching principle can be used to offset the interest rate risk of the liability with
the asset. This means that the investor should purchase a ZCB with duration which is equal to
the duration of the liability. Thus when the liability matures the ZCB matures and the risk of
interest rate is mitigated and the liability is removed from the investor account.
Part d:
Part (i):
The Sale price of the bond is calculated and highlighted in the table below,
Figure 8: Sale Price of Bond B
Source: By the Author
Part (ii):
The holding period return for bond B for the two year period is shown below,

6BOND VALUATION
Figure 9: Holding Period Return
Source: By the Author
Part e:
The price of the corporate bond incorporating the probability of default is given in the table
below,
Figure 10: Risky Bond
Source: By the Author

7BOND VALUATION
References and Bibliographies:
Barth, M.E., Landsman, W.R. and Rendleman Jr, R.J., 2000. Implementation of an option
pricing-based bond valuation model for corporate debt and its components. Accounting
Horizons, 14(4), pp.455-479.
Kim, I.J., Ramaswamy, K. and Sundaresan, S., 1993. Does default risk in coupons affect the
valuation of corporate bonds?: A contingent claims model. Financial Management, pp.117-
131.
King, R., 1986. Convertible bond valuation: An empirical test. Journal of Financial
Research, 9(1), pp.53-69.
Litterman, R. and Iben, T., 1991. Corporate bond valuation and the term structure of credit
spreads. Journal of portfolio management, 17(3), p.52.