Question

Randy bought a zero coupon bond and a TIPS 5 years ago for $2,500 each. Both had 10 years to maturity. The TIPS's coupon was 2% while the zero coupon bond will be redeemed for $3,000. What should the maximum real value of his bonds be if he tries to sell them today? Select the best answer from the choices provided. $250 $750 $5,250 $5,750

Answer 1

So, we have that the final value of the zero coupon bond after ten years will be 3000$. The TIPS mature after 10 years, but the interest will be calculated only for 5 years. Each year of interest, the TIPS gains 2%*2500=2*25=50$. Hence the TIPS gains 50$ for each year of interest. Since the interest is not compounding, it will gain 5*50=250$ in value. Hence its total value after ten years is 2500+250=2750$. The total maximum value of the two assets combined is 3000+2750=5750$ and it is attained after 10 years. If one things that money is more important now than in 10 years, the assets could be sold at a lower price; nonetheless their max value never exceeds choice d)=5.750$