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Treasury bond at a government bond auction

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An investment bank purchased a Treasury bond at a government bond auction today. This bond has exactly 10 years to maturity and will pay annual coupons of 1% per annum. All bonds in this issue (i.e. Treasury bonds with a coupon rate of 1% per annum paid yearly with 10 years to maturity) are trading in the bond market now at their face value of $1,000,000. Rather than just buy-and-hold this bond, the investment bank decides to strip the coupon payments off this newly issued 10 year to maturity bond to a zero coupon bond and a separate 10 year income only annuity; rights to payments from the zero coupon bond and the separate annuity stream will be sold to investors.

  • If the zero-coupon bond can be sold at a yield of 0.8% per annum (paid yearly), what is its principle payment worth today?
  • What is the value today of the income stream (annuity of coupons) if sold at the yield of 0.8% per annum (paid yearly)?
  • What is the dollar (and percent) gain made by the investment bank? Briefly comment on this transaction from the investment bank's perspective.

Reference no: EM132569591

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