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Question 1

Name two interest rates associated with pricing a bond. Describe each one of them and how they are used.

(i) Fixed rate bond

In a fixed rate bonds, the interest remains fixed throughout the period of the bond. Due to its constant interest rate, fixed rate bonds are said to be resistant towards any changes or fluctuations in the current money market. However, in some cases, a bond’s coupon payment is allowed to vary over time.

(ii) Floating rate bond

Floating rate bonds are bond that have a fluctuating interest rate (or called as variable coupons) as per the current money market reference rate plus spread.  The spread is a rate that remains constant. If a floating rate bond has quarterly coupons, i.e. they pay out interest every three months, though counter examples do exist. At the beginning of each coupon period, the coupon is calculated by taking the fixing of the current money market reference rate for that day and adding the spread.

Question 2

What is the relationship between bond prices and interest rates? How can we use this relationship to estimate the value of a bond?

* There is an adverse relationship between bond price and interest rates. It is showed when a market interest rates increase and exceeding the interest rate that was paid by particular bond, the price that investors will have pay for the bonds will decrease. While if the market interest rate decrease and pay less than interest rate paid by a particular bond, the price investors will have to pay for the bond increase.

Question 3

What is the premium bond? Discount bond? How do they differ from each other?

Premium Bond:

A bond that sells above its par value; occurs whenever the going rate of interest is below the coupon rate.

e.g:

Input: 15 5 100 1000

N

FV

PMT

P

I/YR

Output: - 1 518.98

When I/YR than coupon rate, PV than par value...