Given the Opportunity to Invest in One of the Three

question 52

Essay

Given the opportunity to invest in one of the three bonds listed below, which would you purchase? Assume an interest rate of 7%.
B.If funds remain, one may purchase Bond B also since both Bonds B and C are underpriced.
$\begin{array}{lllrl}\text { Bond } & \text { Face Value } & \text { Annual Coupon Rate } & \text { Maturity}& \text { Price } \\\text { A } & \$ 1,000 & 4 \% & 1 \text { year } & \$ 990 \\\text { B } & \$ 1,000 & 7.5 \% & 17 \text { years } & \$ 990 \\\text { C } & \$ 1,000 & 8.5 \% & 25 \text { years } & \$ 990\end{array}$

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Definitions:

Systematic Risk

The inherent risk that affects the entire market or a certain segment of the market, often influenced by factors like political, economic, and interest rate changes that cannot be mitigated through diversification.

Firm-specific Risk

The type of risk that affects a particular company or industry, as opposed to systemic risk, which affects the entire market.

Correlation Coefficient

A statistical measure that describes the extent to which two variables fluctuate together, ranging from -1 (perfect negative correlation) to +1 (perfect positive correlation).

Covariance

A measure of the degree to which two variables move in relation to each other, indicating the direction of their relationship.