Question: A firm issues 1 5-year, zero-coupon bonds with a face value of $ 1,000 each. The current market yield for similar debt is 12 percent.
(a) At what price can the bonds be sold?
(b) Assuming that market interest rates do not change, plot the market price of the zero-coupon bonds as a function of their remaining life. Compute their market price after 2, 5, and 8 years.
(c) Assume that a few days after the bonds were originally issued, market interest rates for similar 15-year debt have increased to 14 percent. At what price should the bonds now trade?
(d) Assume normal bonds specifying regular annual interest payments of 12 percent and sold at face value were issued at the same time as the zero-coupon bonds. Given the conditions under (c) above, at what price should these bonds trade? Compare your answers under (c) and (d) and try to explain the difference.