- 12 Marks
Question
ABE has surplus cash which can be invested for at least five years. The company has consulted you to help them choose an investment that gives the shortest recovery period. The company presented the information on two types of bonds as follows:
| Bond | Redemption | Nominal Value (GH¢) | Redemption Value | Coupon Rate (%) | Price (GH¢) |
|---|---|---|---|---|---|
| A | 5 years | 1,000 | At par | 7.00 | 950 |
| B | 6 years | 1,000 | 5% premium | 7.50 | 1,010 |
Required:
Use the Macaulay Duration method to advise ABE on the best bond option to select for their investment. (12 marks)
Answer
Yield to Maturity for Bond A:
Conclusion:
The company should select Bond A for the investment since it has a shorter duration (4.4 years) compared to Bond B (5.06 years). Bond A allows the principal and interest to be recovered more quickly, making it a less risky investment.
- Tags: Bond duration, Bonds, Investment decisions, Macaulay duration, Risk Management
- Level: Level 3
- Topic: Discounted cash flow techniques
- Series: MAY 2017
- Uploader: Dotse