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What basic trading principle is involved in this situation

Dave and Marlene Carter live in Boston area, where Dave a successful orthodontics practices. Dave and Marlene have built up a sizable investment portfolio and have always had a major portion of their investments in fixed-income securities. They adhere to a fairly aggressive investment posture and actively go after attractive current income and substantial capital gains. Assume that it is now 2020 and Marlene is currently evaluating two investments decisions: one involves an addition to portfolio, the other a revision to it. The Carter’s first investment decision involves a short-term trading opportunity. In particular, Marlene has a chance to buy a 7.5%, 25-year bond that currently priced at $852 to yield 9%; she feels that in two years the promised yield of the issue bond drop to 8%. The second one is bond swap. The Carters hold some Beta Corporation 7%, 2033 that bonds are currently priced at $785. They want to improve both current income and yield-to-maturity, and are considering one of three issues as a possible swap candidate: (a) Dental Floss, Inc., 7.5%, 2045, currently priced at $780; (b) Root Canal Products of America, 6.5%, 2033, selling at $885; and (c) Kansas City Insurance, 8%, 2034, priced at $950. All of swap candidates are of comparable quality and have comparable issue characteristics. Questions: Regarding the short-term trading opportunity;

  • What basic trading principle is involved in this situation?
  • If Marlene’s expectations are correct, what will the price of this bond be in two years?
  • What is the expected return on this investment?
  • Should this investment be made? Why?
  • Compute the current yield and the promised yield (using semiannual compounding) for the bond the Carters currently hold and for each the three swap candidates.
  • Do any of the three swap candidates provide better current income and/or current yield than the Beta Corporation bonds the Carters hold now? If so, which one(s)?
  • Do you see any reason why Marlene should switch from her present bond holding into one of the other three issues? If so, which swap candidate would be the best choice? Why?

Regarding with bond swap opportunity;

  • Compute the current yield and the promised yield (using semiannual compounding) for the bond the Carters currently hold and for each the three swap candidates.
  • Do any of the three swap candidates provide better current income and/or current yield than the Beta Corporation bonds the Carters hold now? If so, which one(s)?
  • Do you see any reason why Marlene should switch from her present bond holding into one of the other three issues? If so, which swap candidate would be the best choice? Why?