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Two 20-year maturity mortgage-backed bonds are issued. The first bond has a par value of $10,000 and promises to pay a 10.5 percent annual coupon, while the second is a zero coupon bond that promises to pay $10,000 (par) after 20 years, with interest accruing at 10.0 percent.

Two 20-year maturity mortgage-backed bonds are issued. The first bond has a par value of $10,000 and promises to pay a 10.5 percent annual coupon, while the second is a zero coupon bond that promises to pay $10,000 (par) after 20 years, with interest accruing at 10.0 percent. At issue, bond market investors require a 12.0 percent interest rate on both bonds.

 

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a. What is the initial price on each bond?

b. Now assume that both bonds promise interest at 10.5 percent, compounded semiannually. What will be the initial price for each bond?

c. If market interest rates fall to 9.5 percent at the end of the fifth year, what will be the value of each bond, assuming annual payments as in (a) (state both as a percentage of par value and actual dollar value)?

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