A bond dealer buys $1,000,000 of a new issue of Government of Canada 10 year bonds (paying semi-annual coupons)for $1,000,000.The coupons are stripped and sold immediately for $483,517.93.If the remaining strip bond is redeemed at par in 10 years,what yield rate j₂ does the dealer earn?

Question

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The dealer is buying a 10-year bond, so we know that there will be 20 coupon payments (semi-annual payments for 10 years). We also know that the dealer paid $1,000,000 for the bond and received $483,517.93 for the stripped coupons, leaving $516,482.07 invested in the bond.

Using a financial calculator or Excel, we can solve for the bond's yield rate (which is also the dealer's yield rate) by setting the present value to the remaining investment ($516,482.07), the future value to the face value of the bond ($1,000,000), the number of periods to 20, and the payment to the semi-annual coupon payment ($30,000). Solving for the yield rate gives us 6.72%.

Therefore, the dealer's yield rate is 6.72%, which makes the best choice B.

A Bond Dealer Buys $1,000,000 of a New Issue of Government