My answer is different from our guests. We may have made different assumption, I don't know.
The US government issued a Bond on June 1, 2010 to mature June 1, 2030. The coupon on this bond was 4% paid semi-annually on June 1 and on December 1. I wish to buy this bond on Monday, Nov. 2, 2015 at a yield of 3%. What is the Price that I should pay, as well as the accrued interest on this bond? Thank you.
Assumptions
1) The 4% and 3% are 6 monthly rates (not annual rates)
2) Face value = Redeption value = $100
so
F=C=$100
r=4% =0.04
I = Fr = 100*0.04 = $4 That is, a $4 is paid every 6 months
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i= 3% = 0.03
Because you want less interest than the coupon rate this means that you are prepared to pay a premium - this means that you are prepared to pay more than $100 for the bond.
Now, you are buying the bond in the middle of a coupon cycle so you need to first work out how much you would pay for it at the beginning of that cycle.
It is easiest for you to draw up a rough time line to display what is happening.
Now the beginning of the cycle BEFORE is 1st June 2015
The next period will begin on 1st Dec 15 (but we do not need that just yet)
From the 1st june15 till 1st June 30 is 15 years which is 30 rate perids
n=30
First off you need to work out the price that will yeild 3% back to that date.
\(P_1=C+\left[(I-Ci)\times \frac{(1-(1+i)^{-n}}{i}\right]\\ P_1=100+\left[(4-100*0.03)\times\frac{1-(1.03)^{-30}}{0.03}\right]\\ P_1=100+\left[1\times 19.60044135\right]\\ P_1=119.60044135\\ P_1=\$119.60\)
So, if you bought the bonds on 1st june 15 you would have paid $119.60
But you didn't. You bought them later so you will get some ' free' interest period.
So you will be prepared to pay a little more.
So you need to work out how many free interest days that there are.
From the 1st of June to the 2nd Nov = 30+31+31+30+31+1 = 154 days
And how long it will be till the next cycle begins
And from 1st June to 1st December = 30+31+31+30+31+30=183 days
So the free portion is 154/183 of a cycle.
\(S=P_1(1+i)^{154/183}\\ S=119.60\times(1.03)^{154/183}\\ S=$122.61 \)
So you should pay a maximum of $122.61 per $100 Coupon.