Reference no: EM132999483

Question - As the newest recruit within the investment banking division of a global financial institution, you are tasked with structuring debt and fixed income contracts for your bank's clients. Earlier this week you purchased an Australian Treasury Bond at the Australian Office of Financial Management auction. This bond has exactly 20 years to maturity and will pay semi-annual coupons of 1.25% per annum. All bonds in this issue (i.e. Treasury bonds with a coupon rate of 1.25% per annum paid yearly with 20 years to maturity) are currently trading in the bond market at their face value of $1,000,000. Rather than just buy-and-hold this bond, to create an additional return in this low-interest-rate environment, you decided to strip the coupon payments off this bond to create income only annuity and a separate zero-coupon bond; rights to payments from the zero-coupon bond and the separate annuity stream will be sold to two investors.

i. If the zero-coupon bond can be sold at a yield of 1% per annum (with semi-annual interest compounding), what is the principal payment worth today?

ii. What is the value today of the income stream (annuity of coupons) if sold at the yield of 1% per annum (with semi-annual interest compounding)?

iii. Provide a short summary to your supervisor what is the dollar (and percent) return made by the investment bank from this transaction? Briefly comment on this transaction from the investment bank's perspective.