TRADING CASE B01
Bond valuation in a three-year market
LEARNING OBJECTIVE
Connect time value of money to the cash flows and prices of coupon and zero-coupon bonds.
KEY CONCEPTS
Discounting | Bond cash flows | No-arbitrage pricing | Short selling
HOW THE CASE WORKS
The case lasts three years. You trade on Day 1 of each year. When trading closes, the year ends and your cash and bond payments are updated. After Year 3, all positions are converted to cash.
BOND PAYMENTS
| Instrument | Year 1 | Year 2 | Year 3 |
|---|---|---|---|
| 20% coupon bond | 20 | 20 | 120 |
| Zero-coupon bond | 0 | 0 | 100 |
INTEREST RATES
The interest rate is 25% each year. You earn 25% on positive cash and pay 25% on borrowed cash. Interest is calculated before coupons and face value are paid.
TRADING RULES
- Both bonds have a face value of 100.
- You may buy, sell, borrow, lend, and sell bonds short.
- If you are short, you must pay the bond's coupons and face value when due.
- Students set prices by entering bids and asks.
AFTER TRADING CLOSES
Interest is added to, or charged against, your closing cash.
Bond payments are then added for long positions or charged for short positions.
After Year 3, your final cash balance is calculated.
PERFORMANCE: Trading bonus (grade cash) per trial = 0.0001 x closing market cash. Positive wealth adds grade cash; negative wealth subtracts it. Results accumulate across independent trials.