USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The following information is given concerning a pure yield pick-up swap: You currently hold a 20-year, Aa 2 percent coupon bond priced to yield 9.5 percent. As a swap candidate, you are considering a 20-year, Aa 14 percent coupon bond priced to yield 10.00. Assume a reinvestment rate of 11 percent, semiannual compounding, and a one-year workout period.

-Refer to Exhibit 13.8. The interest on one coupon for the candidate bond is
A) $70.00.
B) $3.58.
C) $3.85.
D) $8.35.
E) $5.38.

Question

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The following information is given concerning a pure yield pick-up swap: You currently hold a 20-year, Aa 2 percent coupon bond priced to yield 9.5 percent. As a swap candidate, you are considering a 20-year, Aa 14 percent coupon bond priced to yield 10.00. Assume a reinvestment rate of 11 percent, semiannual compounding, and a one-year workout period.
 
-Refer to Exhibit 13.8. The interest on one coupon for the candidate bond is
A) $70.00. 
B) $3.58. 
C) $3.85. 
D) $8.35. 
E) $5.38.

Quizplus · Accepted Answer

The interest on one coupon for the candidate bond can be calculated as (14% x $1,000) / 2 = $70.00 / 2 = $35.00. Since the coupon payments are semi-annual, the interest earned after 6 months at a reinvestment rate of 11% can be calculated as ($35.00 x 0.11) / 2 = $1.93. At the end of year 1, the coupon payment and the interest earned on it can be reinvested at the same rate of 11%. Therefore, the total interest earned on one coupon for the candidate bond is $1.93 + $1.92 (the interest earned on the reinvested $35.00 after 6 months) = $3.85.