You Are Considering the Purchase of Two $1,000 Bonds,both Issued

question 12

Essay

You are considering the purchase of two $1,000 bonds,both issued by Tranig Corp.Your expectation is that interest rates will drop,and you want to buy the bond which provides the maximum capital gains potential.The first Tranig bond has a coupon rate of 6% with five years to maturity,while the second has a coupon rate of 9% and comes due six years from now.If market rates of interest are 8% for both bonds,which bond has the best price potential? (Use duration to answer the question. )
Coupon rate 6% $\begin{array}{|l|l|l|l|l|r|}\hline(1)&(2) & (3) & (4) & (5) & (6) \\\hline && \text { PV Factor } & \text { PV of } & \text { Weights } & \\\hline \text { Year } & \text { Cash Flow } & \text { a } 10 \% & \text { Cash Flow } & \text { (4) Value } & \text { (1) } \times(5) \\\hline 1 & \$ 60 & .926 & \$ 55.56 & .06035 & .06035 \\\hline 2 & 60 & .857 & 51.42 & .05585 & .11170 \\\hline 3 & 60 & .794 & 47.64 & .05175 & .15525 \\\hline 4 & 60 & .735 & 44.10 & .04790 & .19160 \\\hline 5 & 60 & .681 & 40.86 & .04438 & .22190 \\\hline 5 & 1,000 & .681 & 681.00 & .73975 & 3.69875 \\\hline\end{array}$
$\mathrm{PV} \text { of Bond }=\$ 920.58 \text { Duration }=4.43955$ Coupon rate 9%

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