An analyst is considering a bond for purchase. The bond has a coupon that resets semiannually and is determined by the following formula: coupon = 12% - (3.0 * 6-month Treasury bill rate)
Identify what type of bond this is, and calculate the coupon rate this bond would reset to if the 6-month Treasury bill rate is 4.5%.
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A. B. C.B
Based on the given information, the bond in question has a coupon rate that resets semiannually based on a specific formula. To determine the type of bond and calculate the coupon rate, let's analyze the given formula:
coupon = 12% - (3.0 * 6-month Treasury bill rate)
The formula suggests that the coupon rate of the bond is determined by subtracting three times the 6-month Treasury bill rate from 12%.
Inverse Floaters: In an inverse floater bond, the coupon rate moves in the opposite direction of an underlying benchmark rate. In this case, since the coupon rate decreases as the Treasury bill rate increases, it indicates an inverse relationship. Therefore, we can conclude that the bond in question is an inverse floater.
Calculating the Coupon Rate: To calculate the coupon rate that the bond would reset to, we need to substitute the given 6-month Treasury bill rate of 4.5% into the formula.
coupon = 12% - (3.0 * 4.5%)
Calculating the right-hand side of the equation: 3.0 * 4.5% = 0.135
Substituting the result into the equation: coupon = 12% - 0.135 coupon = 11.865%
Therefore, if the 6-month Treasury bill rate is 4.5%, the coupon rate of this bond would reset to 11.865%.
In summary, the correct answer is: A. This bond is an inverse floater, and the coupon would reset to 11.865%.