- 20 Marks
FM – May 2024 – L3 – SB – Q4 – Investment Appraisal Techniques
Analyze forward rates and bond valuation, calculate bond prices and YTM, evaluate price changes over time, and interpret modified duration.
Question
The following information is on 3 default-free bonds.
| Bonds | Price (₦) | Coupon (%) | Redemption Value (₦) | Maturity (Years) |
|---|---|---|---|---|
| A | 105 | 10 | 100 | 1 |
| B | 96 | 4 | 100 | 2 |
| C | 98 | 6 | 100 | 3 |
Required:
a. Estimate the two-year forward rate at the end of year 1 and the one-year forward rate at the end of year 2.
(5 Marks)
b. You are considering buying a three-year 9% annual-coupon paying bond with a face value of ₦1,000. The bond is default-free.
i. Calculate the price of the bond and its yield to maturity. Clearly explain why you may not realize the calculated yield.
(6 Marks)
ii. One year after purchasing the bond at the price you have calculated, if there are no changes in market interest rates, do you expect the price of the bond to increase, fall, or remain constant? Explain.
(2 Marks)
iii. Estimate and interpret the modified duration of the bond. Identify the key limitations of modified duration in bond analysis.
(7 Marks)
(Total 20 Marks)
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