I'm studying Financial Engineering, a subject I'm completely new to.

I'm using Principles of Financial Engineering 3rd Edition and trying to solve the exercises of the chapter on Cash Flow Engineering.

The first question states:

You have a 4-year coupon bond that pays semiannual interest. The coupon rate is 8% and the par value is 100.
a. Can you construct a synthetic equivalent of this bond? Be explicit and show your cash flows.

Unfortunately, I don't know how to proceed with this. I'm not able to understand how the cash flows would be split.

Would it be 8 separate payments?

And if yes, what would the payment amount be at each ti, i=1,2,...8 and why?

  • 2
    $\begingroup$ Try thinking about the following things. Do you understand exactly what the payouts are of your 4-year coupon bond (that pays semi annually)? How many payouts does your bond have? when are they? what is the amount at each period? Once you got that figured out, how does having zero coupons help you in replicating your original bond? $\endgroup$ – mbison Sep 23 '15 at 22:44
  • $\begingroup$ "Annual coupon of x paid semiannually" means payments of x/2 each, spaced 6 months apart. $\endgroup$ – Alex C Sep 24 '15 at 2:21

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