This solves for Hull 4.2: what is price of 2-year bond that pays a 6% semi-annual coupon given a zero rate curve. For more financial risk videos, visit our website! www.bionicturtle.com
Hi. Thanks for the clear explanation. When I try it on my BA II Plus there is a slight deviation from the final correct answer. Consider this example: Calculate the value of a 3-year, 5% annual-coupon bond, Cash Flow=50, Principal = 1000. Spot Rates: 1 year:3%, 2 year: 4%, 3 year: 5% According to the formula: 50/1.03 + 50/(1.04)^2 + 50/(1.05)^3 = 48.54+46.23+907.03 = $1001.80 However when I do this on the BAII as per your explanation, the price comes to 48.52+46.16+903.74 = $998.42 (which is incorrect) Where am I going wrong.
well your 3rd year cash flow is wrong it should have the coupon amount and payment in the numerator: 50+1000/ (1.05)^3 = $907.049, that will get you within .02 cents.
Exponential function is a good way assuming continuous compounding and your way is probably the way to go taking test like CFA. If you are interested in what leads to the difference, search for Taylor Expansion for exponential and binomial functions, you will be able to see the first few expansion items are the same so they can approximate each other when n and r are small but not necessarily hold true otherwise, for example, huge difference at the balloon payment using two approaches.
