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Hi John i was going through the June 2010 question 2 and i didn’t understand this bit. the questions gave 3% 5 year variable loan with a current yield of 5%. the solution says that the exercise price is determined by an equivalent zero coupon bond . this is calculate as follow
3 million x 1.08–5.( it’s 1.08 raised to the power 5)
please i dont understand this bidThe current bond is giving a yield of 8% (on the statements it says yield rate + 3%).
(the examiner was naughty is using ‘yield’ in two places, which is confusing).Zero coupon means no interest.
So the market value is the present value of the repayment in 5 years time of 3,000, discounted at 8%. (that is what the 1.08^(-5) is, although it would be easier simply to use the 5 year discount factor at 8% from the tables!)
if zero coupon means no interest, what is the the 8%? is it not interest on the 3,000,000
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