Answer: £1,028.

## Detailed Explanation To calculate the current value (price) of the bond, we need to discount all future cash flows at the yield to maturity (YTM) of 3%. **Bond Details:** - Face value: £1,000 - Coupon rate: 4% (annual) - Annual coupon payment: £1,000 × 4% = £40 - Maturity: 3 years - YTM: 3% **Cash Flows:** - Year 1: £40 coupon payment - Year 2: £40 coupon payment - Year 3: £40 coupon payment + £1,000 principal repayment = £1,040 **Present Value Calculation:** 1. **Year 1 coupon:** £40 ÷ (1.03)¹ = £40 ÷ 1.03 = £38.83 2. **Year 2 coupon:** £40 ÷ (1.03)² = £40 ÷ 1.0609 = £37.70 3. **Year 3 cash flow:** £1,040 ÷ (1.03)³ = £1,040 ÷ 1.092727 = £951.70 **Total Present Value:** £38.83 + £37.70 + £951.70 = **£1,028.23** **Why the bond trades at a premium:** - The coupon rate (4%) is higher than the YTM (3%) - Investors are willing to pay more than face value for a bond that pays higher coupons than the current market rate - The bond's price (£1,028) is above its par value (£1,000) **Verification using bond pricing formula:** \[P = \frac{C}{(1+r)^1} + \frac{C}{(1+r)^2} + \frac{C+FV}{(1+r)^3}\] \[P = \frac{40}{1.03} + \frac{40}{1.03^2} + \frac{40+1000}{1.03^3}\] \[P = 38.83 + 37.70 + 951.70 = 1,028.23\] Therefore, the current value of the bond is closest to **£1,028** (Option B).

Author: LeetQuiz .