# Practice Problems for FE 486B Thursday, February 2, a) Which choice should you make if the interest rate is 3 percent? If it is 6 percent?

Save this PDF as:

Size: px
Start display at page:

Download "Practice Problems for FE 486B Thursday, February 2, 2012. a) Which choice should you make if the interest rate is 3 percent? If it is 6 percent?"

## Transcription

1 Practice Problems for FE 486B Thursday, February 2, ) Suppose you win the lottery. You have a choice between receiving \$100,000 a year for twenty years or an immediate payment of \$1,200,000. a) Which choice should you make if the interest rate is 3 percent? If it is 6 percent? For both interest rates you need to figure out the present value of the 20 annual payments of \$100,000. Assuming that each annual payment is received at the end of the year (so that the first payment is received after one year), the equation for the discounted present value of the 20 annual payments reads: Present value = \$100,000/(1 + i) + \$100,000/(1 + i) 2 + \$100,000/(1 + i) \$100,000/(1 + i) 20. For the 3 percent interest rate (i = 0.03), the present value is: PV = 1,487, For the 6 percent interest rate (i = 0.06), the present value is: PV = 1,146, Note that the present value of fixed future cash flows is lower the higher the interest rate. With an interest rate of 3 percent, you should take the 20 annual payments of \$100,000. With an interest rate of 6 percent, you are better off taking the immediate payment of \$1,200,000. b) For which range of interest rates should you take the immediate payment? From your answer in part (a), it is clear that you should take immediate payment for any interest rate above 6 percent. Even with an interest rate just below 6 percent (e.g., 5.8 percent), you will still be better off in present value terms with the immediate payment. In fact, you can solve for the interest rate at which the present value of the 20 annual payments exactly equals \$1,200,000. This is difficult without a financial calculator, but you can check that an interest rate of 5.45 percent would make you indifferent between the two options. You should take immediate payment for any interest rate above 5.45 percent. 2) Describe how (in some detail) each of the following events affects stock prices and bond prices (explain the different effects between the two) : a) The economy enters a recession. Often during recessions, interest rates tend to decrease. This would increase both stock and bond prices positively. However, company s earnings will fall as well. Lower interest rates and lower earnings impact stock prices in opposite directions. The earnings impact usually outweighs the interest rate impact on stock prices during a recession.

2 b) A genius invents a new technology that makes factories more productive. Future expected earnings of the company will increase, likely increasing the dividend paid to the stockholders. This increases the value of the company s stock. Bond prices are not affected because the coupon payments are not affected. c) The Federal Reserve raises its target for interest rates. Higher interest rates reduce both stock and bond prices. d) People learn that major news about the economy will be announced in a few days, but they don t know whether it is good news or bad news. This event increases uncertainty and can be thought of as increasing the risk premium that gets added to the safe interest rate to determine the present value of future income. With a higher interest rate, future asset income gets discounted at a higher rate and both stock and bond prices will fall. 3) Consider two bonds. Each has a face value of \$100 and matures in ten years. One has no coupon payments, and the other pays \$10 per year. a) Calculate the price of each bond if the interest rate is 3 percent and if the interest rate is 6 percent. No coupon bond: Price of bond = \$100/( ) 10 = \$74.63 Price of bond = \$100/( ) 10 = \$55.87 Coupon bond: Price of bond = \$10/( ) + \$10/( )2 + + \$110/( ) 10 = \$ Price of bond = \$10/( ) + \$10/( )2 + + \$110/( ) 10 = \$ b) When the interest rate rises from 3 percent to 6 percent, which bond price falls by a larger percentage? Explain why. Percentage change (no coupon) = ( )/74.63 = 0.25 = 25%

3 Percentage change (coupon) = ( )/ = 0.19 = 19% The drop in the no-coupon bond is larger in percentage terms. On average, the coupon bond does not get discounted as heavily as the no-coupon bond when interest rates increase. 4) Consider two stocks. For each, the expected dividend next year is \$100 and the expected growth rate of dividends is 3 percent. The risk premium is 3 percent for one stock and 8 percent for the other. The economy s safe interest rate is 5 percent. a) What does the difference in risk premiums tell us about the dividends from each stock? The stock with the higher risk premium has dividends that are more variable. Just because the expected dividend for each stock is the same, this does not mean that the variance on the dividend return is the same. b) Use the Gordon growth model to compute the price of each stock. Why is one price higher than the other? The Gordon growth model says that the price of the stock (P) can be calculated as follows: P = D / (i g) where D is the expected dividend, i is the risk-adjusted interest rate, and g is the expected growth rate of the dividend. The two stock prices are: Price of stock with 3% risk premium = \$100 / ( ) = \$2000. Price of stock with 8% risk premium = \$100 / ( ) = \$1000. The stock that is less risky has a higher price due to the fact that it yields a more certain return. In addition, note that the 3% growth rate of the dividend exactly offsets the 3% risk premium, resulting in a fairly certain 5% return. 5) Suppose it is 2020 and the one-year interest rate is 4 percent. The expected one-year rates in the following four years (2021 to 2024) are 4 percent, 5 percent, 6 percent and 6 percent. a) Assume the expectations theory of the term structure, with no term premium. Compute the interest rates in 2020 on bonds with maturities for one, two, three, four and five years. Draw a yield curve.

4 The interest rates are calculated as follows: 1-year rate in 2020: 4% 2-year rate in 2020: (4% + 4%)/2 = 4% 3-year rate in 2020: (4% + 4% + 5%)/3 = 4.33% 4-year rate in 2020: (4% + 4% + 5% + 6%)/4 = 4.75% 5-year rate in 2020: (4% + 4% + 5% + 6% + 6%)/5 = 5% Drawing the yield curve will show a flat yield curve for the first two years. After year 2, the yield curve is upward sloping. b) Redo part (a) with term premiums. Assume the term premium for an n-year bond, τ n, is (n/2) percent. For example, the premium for a four-year bond is (4/2)% = 2%. The interested rates are calculated as follows: 1-year rate in 2020: 4% + (1/2)% = 4.5% 2-year rate in 2020: (4% + 4%)/2 + (2/2)% = 5% 3-year rate in 2020: (4% + 4% + 5%)/3 + (3/2)% = 5.83% 4-year rate in 2020: (4% + 4% + 5% + 6%)/4 + (4/2)% = 6.75% 5-year rate in 2020: (4% + 4% + 5% + 6% + 6%)/5 + (5/2)% = 7.5% Drawing the yield curve will show an upward-sloping yield curve throughout. Adding term premiums results in a steeper yield curve. 6) Explain what happens in an asset-price bubble. Explain what happens in an asset-price crash. In an asset price bubble, something else other than a change in the interest rate or a change in the expected income of the asset causes the asset price to rise. In most cases, the asset price rises because people expect it to rise. If, for example, we all expect the price of stock A to rise, then there is an increase in the demand for stock A and this causes the price of stock A to actually rise. It does not matter if the expectation was justified or not as long as we all believe it. A bubble forms when the increase in the price of the asset causes further increases in demand for the asset and further increases in the price of the asset. Inevitably, the price rises so high that people fear it cannot continue and demand for the asset falls. As demand falls, the price will fall; this leads to an asset-price crash. Eventually the price of the asset returns to what the classical theory would predict.

5 7) Which asset prices are most volatile? Why? Long-term bond prices are more volatile than short-term bond prices because changes in the interest rate will have a larger impact on payments that occur further into the future. Since the expected income flow of the bond is known at the time of purchase (barring default), only changes in the interest rate will change the present value of the expected income of the bond. Stock prices are more volatile than bond prices, long or short term, because the stock price depends not only on the interest rate but also on expected income.

### 1. Present Value. 2. Bonds. 3. Stocks

Stocks and Bonds 1. Present Value 2. Bonds 3. Stocks 1 Present Value = today s value of income at a future date Income at one future date value today of X dollars in one year V t = X t+1 (1 + i t ) where

### The Term Structure of Interest Rates CHAPTER 13

The Term Structure of Interest Rates CHAPTER 13 Chapter Summary Objective: To explore the pattern of interest rates for different-term assets. The term structure under certainty Forward rates Theories

### Econ 330 Exam 1 Name ID Section Number

Econ 330 Exam 1 Name ID Section Number MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) If during the past decade the average rate of monetary growth

### Answer Key to Midterm

Econ 121 Money and Banking Instructor: Chao Wei Answer Key to Midterm Provide a brief and concise answer to each question. Clearly label each answer. There are 50 points on the exam. 1. (10 points, 3 points

### Answers to End-of-Chapter Questions

Answers to End-of-Chapter Questions 1. The bond with a C rating should have a higher risk premium because it has a higher default risk, which reduces its demand and raises its interest rate relative to

### Term Structure of Interest Rates

Appendix 8B Term Structure of Interest Rates To explain the process of estimating the impact of an unexpected shock in short-term interest rates on the entire term structure of interest rates, FIs use

### ANSWERS TO END-OF-CHAPTER PROBLEMS WITHOUT ASTERISKS

Part III Answers to End-of-Chapter Problems 97 CHAPTER 1 ANSWERS TO END-OF-CHAPTER PROBLEMS WITHOUT ASTERISKS Why Study Money, Banking, and Financial Markets? 7. The basic activity of banks is to accept

### Chapter 8. Step 2: Find prices of the bonds today: n i PV FV PMT Result Coupon = 4% 29.5 5? 100 4 84.74 Zero coupon 29.5 5? 100 0 23.

Chapter 8 Bond Valuation with a Flat Term Structure 1. Suppose you want to know the price of a 10-year 7% coupon Treasury bond that pays interest annually. a. You have been told that the yield to maturity

### Bonds, Preferred Stock, and Common Stock

Bonds, Preferred Stock, and Common Stock I. Bonds 1. An investor has a required rate of return of 4% on a 1-year discount bond with a \$100 face value. What is the most the investor would pay for 2. An

### Practice Set and Solutions #2

723G26/2012-10-10 Practice Set and Solutions #2 What to do with this practice set? Practice sets are handed out to help students master the material of the course and prepare for the final exam. These

### Money and Banking Prof. Yamin Ahmad ECON 354 Fall 2005

Money and Banking Prof. Yamin Ahmad ECON 354 Fall 2005 Midterm Exam II Name Id # Instructions: There are two parts to this midterm. Part A consists of multiple choice questions. Please mark the answers

### Use the table for the questions 18 and 19 below.

Use the table for the questions 18 and 19 below. The following table summarizes prices of various default-free zero-coupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price

### Econ 121 Money and Banking Fall 2009 Instructor: Chao Wei. Midterm. Answer Key

Econ 121 Money and Banking Fall 2009 Instructor: Chao Wei Midterm Answer Key Provide a BRIEF and CONCISE answer to each question. Clearly label each answer. There are 25 points on the exam. I. Formulas

### EC247 FINANCIAL INSTRUMENTS AND CAPITAL MARKETS TERM PAPER

EC247 FINANCIAL INSTRUMENTS AND CAPITAL MARKETS TERM PAPER NAME: IOANNA KOULLOUROU REG. NUMBER: 1004216 1 Term Paper Title: Explain what is meant by the term structure of interest rates. Critically evaluate

### Yield to Maturity Outline and Suggested Reading

Yield to Maturity Outline Outline and Suggested Reading Yield to maturity on bonds Coupon effects Par rates Buzzwords Internal rate of return, Yield curve Term structure of interest rates Suggested reading

### International Money and Banking: 12. The Term Structure of Interest Rates

International Money and Banking: 12. The Term Structure of Interest Rates Karl Whelan School of Economics, UCD Spring 2015 Karl Whelan (UCD) Term Structure of Interest Rates Spring 2015 1 / 35 Beyond Interbank

### Practice Set #1 and Solutions.

Bo Sjö 14-05-03 Practice Set #1 and Solutions. What to do with this practice set? Practice sets are handed out to help students master the material of the course and prepare for the final exam. These sets

### AFM 271 Practice Problem Set #1 Spring 2005

AFM 271 Practice Problem Set #1 Spring 2005 1. Text problems: Chapter 1 1, 3, 4 Chapter 2 5 Chapter 3 2, 6, 7 Chapter 4 2, 6, 12, 14, 16, 18, 20, 22, 24, 26, 30, 32, 34, 38, 40, 46, 48 Chapter 5 2, 4,

### 7. Bonds and Interest rates

7. Bonds and Interest rates 1 2 Yields and rates I m thinking of buying a bond that has a face value of \$1000, pays semiannual coupons of \$40 and has 7 years to maturity. The market price is \$943. Fixed

### Forward Contracts and Forward Rates

Forward Contracts and Forward Rates Outline and Readings Outline Forward Contracts Forward Prices Forward Rates Information in Forward Rates Reading Veronesi, Chapters 5 and 7 Tuckman, Chapters 2 and 16

### Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS. Peter N. Ireland Department of Economics Boston College. irelandp@bc.edu

Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS Peter N. Ireland Department of Economics Boston College irelandp@bc.edu http://www.bc.edu/~irelandp/ec61.html Chapter 6: The Risk and Term Structure

### Money and Banking Prof. Yamin Ahmad ECON 354 Spring 2006

Money and Banking Prof. Yamin Ahmad ECON 354 Spring 2006 Final Exam Name Id # Instructions: There are 30 questions on this exam. Please circle the correct solution on the exam paper and fill in the relevant

### Principles of Managerial Finance. Lawrence J. Gitman Chad J. Zutter

Global edition Principles of Managerial Finance Fourteenth edition Lawrence J. Gitman Chad J. Zutter This page is intentionally left blank. 278 Part 3 Valuation of Securities Figure 6.2 Impact of Inflation

### CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES

CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES 1. Expectations hypothesis. The yields on long-term bonds are geometric averages of present and expected future short rates. An upward sloping curve is

### CHAPTER 14: BOND PRICES AND YIELDS

CHAPTER 14: BOND PRICES AND YIELDS PROBLEM SETS 1. The bond callable at 105 should sell at a lower price because the call provision is more valuable to the firm. Therefore, its yield to maturity should

### Finance for Cultural Organisations Lecture 5. Interest Rates and Bond Valuation

Finance for Cultural Organisations Lecture 5. Interest Rates and Bond Valuation Lecture 5: Interest Rates and Bond Valuation Know the important bond features and bond types Understand bond values and why

### Interest Rates and Bond Valuation

Interest Rates and Bond Valuation Chapter 6 Key Concepts and Skills Know the important bond features and bond types Understand bond values and why they fluctuate Understand bond ratings and what they mean

### The Time Value of Money

The Time Value of Money This handout is an overview of the basic tools and concepts needed for this corporate nance course. Proofs and explanations are given in order to facilitate your understanding and

### CHAPTER 5. Interest Rates. Chapter Synopsis

CHAPTER 5 Interest Rates Chapter Synopsis 5.1 Interest Rate Quotes and Adjustments Interest rates can compound more than once per year, such as monthly or semiannually. An annual percentage rate (APR)

### Yield Curve. Term Structure. Observed Yield Curves

Yield Curve The term structure refers to the relationship between short-term and long-term interest rates. The yield curve plots the yield to maturity against the term to maturity (figure 1). One plots

### CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES

CHAPTER : THE TERM STRUCTURE OF INTEREST RATES CHAPTER : THE TERM STRUCTURE OF INTEREST RATES PROBLEM SETS.. In general, the forward rate can be viewed as the sum of the market s expectation of the future

### Midterm Exam 1. 1. (20 points) Determine whether each of the statements below is True or False:

Econ 353 Money, Banking, and Financial Institutions Spring 2006 Midterm Exam 1 Name The duration of the exam is 1 hour 20 minutes. The exam consists of 11 problems and it is worth 100 points. Please write

### Asset Prices and Interest Rates

C H A P T E R 16 Asset Prices and Interest Rates Notes to the Instructor Chapter Summary This chapter develops the theory of how asset prices are determined using the standard model of valuing income streams

### Practice Questions for Midterm II

Finance 333 Investments Practice Questions for Midterm II Winter 2004 Professor Yan 1. The market portfolio has a beta of a. 0. *b. 1. c. -1. d. 0.5. By definition, the beta of the market portfolio is

### GESTÃO FINANCEIRA II PROBLEM SET 2 - SOLUTIONS

GESTÃO FINANCEIRA II PROBLEM SET - SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 010-011 Yield to Maturity Chapter 8 Valuing Bonds 8-3. The following

### Chapter 6 Interest Rates and Bond Valuation

Chapter 6 Interest Rates and Bond Valuation Solutions to Problems P6-1. P6-2. LG 1: Interest Rate Fundamentals: The Real Rate of Return Basic Real rate of return = 5.5% 2.0% = 3.5% LG 1: Real Rate of Interest

### v. Other things held constant, which of the following will cause an increase in working capital?

Net working capital i. Net working capital may be defined as current assets minus current liabilities. This also defines the current ratio. Motives for holding cash ii. Firms hold cash balances in order

### 2. What is your best estimate of what the price would be if the riskless interest rate was 9% (compounded semi-annually)? (1.04)

Lecture 4 1 Bond valuation Exercise 1. A Treasury bond has a coupon rate of 9%, a face value of \$1000 and matures 10 years from today. For a treasury bond the interest on the bond is paid in semi-annual

### Chapter 8 Interest Rates and Bond Valuation

University of Science and Technology Beijing Dongling School of Economics and management Chapter 8 Interest Rates and Bond Valuation Oct. 2012 Dr. Xiao Ming USTB 1 Key Concepts and Skills Know the important

### Exercise 6 Find the annual interest rate if the amount after 6 years is 3 times bigger than the initial investment (3 cases).

Exercise 1 At what rate of simple interest will \$500 accumulate to \$615 in 2.5 years? In how many years will \$500 accumulate to \$630 at 7.8% simple interest? (9,2%,3 1 3 years) Exercise 2 It is known that

### Econ 116 Mid-Term Exam

Econ 116 Mid-Term Exam Part 1 1. True. Large holdings of excess capital and labor are indeed bad news for future investment and employment demand. This is because if firms increase their output, they will

### Chapter 3 Fixed Income Securities

Chapter 3 Fixed Income Securities Road Map Part A Introduction to finance. Part B Valuation of assets, given discount rates. Fixed-income securities. Stocks. Real assets (capital budgeting). Part C Determination

### Estimating Risk free Rates. Aswath Damodaran. Stern School of Business. 44 West Fourth Street. New York, NY 10012. Adamodar@stern.nyu.

Estimating Risk free Rates Aswath Damodaran Stern School of Business 44 West Fourth Street New York, NY 10012 Adamodar@stern.nyu.edu Estimating Risk free Rates Models of risk and return in finance start

### Chapter Two. Determinants of Interest Rates. McGraw-Hill /Irwin. Copyright 2001 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Two Determinants of Interest Rates Interest Rate Fundamentals Nominal interest rates - the interest rate actually observed in financial markets directly affect the value (price) of most securities

### FIN 472 Fixed-Income Securities Debt Instruments

FIN 472 Fixed-Income Securities Debt Instruments Professor Robert B.H. Hauswald Kogod School of Business, AU The Most Famous Bond? Bond finance raises the most money fixed income instruments types of bonds

### Chapter 4 Problems and Solutions

ECO 3223 - Spring 2007 Chapter 4 1) Compute the future value of \$100 at an 8 percent interest rate five, ten and fifteen years into the future. Future value in 5 years = \$100*(1.08) 5 = \$146.93 Future

### The Yield Curve, Stocks, and Interest Rates

The Yield Curve, Stocks, and Interest Rates The Yield Curve as of 6/26/09 (from Bloomberg.com): Bonds with identical risk, liquidity, and tax characteristics have different interest rates based on time

### How credit analysts view and use the financial statements

How credit analysts view and use the financial statements Introduction Traditionally it is viewed that equity investment is high risk and bond investment low risk. Bondholders look at companies for creditworthiness,

### Chapter 6 The Tradeoff Between Risk and Return

Chapter 6 The Tradeoff Between Risk and Return MULTIPLE CHOICE 1. Which of the following is an example of systematic risk? a. IBM posts lower than expected earnings. b. Intel announces record earnings.

### Fixed Income Securities

3st lecture IES, UK October 7, 2015 Outline Bond Characteristics 1 Bond Characteristics 2 Bond Characteristics Government bond listing Rate Maturity mo/yr Bid Asked Chg Ask yld 3.000 July 12 108:22 108:23-20

### CHAPTER 5 HOW TO VALUE STOCKS AND BONDS

CHAPTER 5 HOW TO VALUE STOCKS AND BONDS Answers to Concepts Review and Critical Thinking Questions 1. Bond issuers look at outstanding bonds of similar maturity and risk. The yields on such bonds are used

### Bond valuation and bond yields

RELEVANT TO ACCA QUALIFICATION PAPER P4 AND PERFORMANCE OBJECTIVES 15 AND 16 Bond valuation and bond yields Bonds and their variants such as loan notes, debentures and loan stock, are IOUs issued by governments

### Rate of Return. Reading: Veronesi, Chapter 7. Investment over a Holding Period

Rate of Return Reading: Veronesi, Chapter 7 Investment over a Holding Period Consider an investment in any asset over a holding period from time 0 to time T. Suppose the amount invested at time 0 is P

### Chapter 7 Bond Markets

1 Chapter 7 Bond Markets Outline Background on Bonds Bond Yields Treasury and Federal Agency Bonds Treasury Bond Auction Trading Treasury Bonds Treasury Bond Quotations Stripped Treasury Bonds Inflation-Indexed

### CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES

Chapter - The Term Structure of Interest Rates CHAPTER : THE TERM STRUCTURE OF INTEREST RATES PROBLEM SETS.. In general, the forward rate can be viewed as the sum of the market s expectation of the future

### Fundamentals of Finance

University of Oulu - Department of Finance Fall 2015 What is it about in finance? Finance is basically nothing else but estimating expected future payoffs, and discounting them with an appropriate discount

### CHAPTER 8 STOCK VALUATION

CHAPTER 8 STOCK VALUATION Answers to Concepts Review and Critical Thinking Questions 5. The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred.

### Financial Markets and Valuation - Tutorial 2: SOLUTIONS. Bonds, Stock Valuation & Capital Budgeting

Financial Markets and Valuation - Tutorial : SOLUTIONS Bonds, Stock Valuation & Capital Budgeting (*) denotes those problems to be covered in detail during the tutorial session Bonds Problem. (Ross, Westerfield

### Chapter 11. Bond Pricing - 1. Bond Valuation: Part I. Several Assumptions: To simplify the analysis, we make the following assumptions.

Bond Pricing - 1 Chapter 11 Several Assumptions: To simplify the analysis, we make the following assumptions. 1. The coupon payments are made every six months. 2. The next coupon payment for the bond is

### CHAPTER 20. Financial Options. Chapter Synopsis

CHAPTER 20 Financial Options Chapter Synopsis 20.1 Option Basics A financial option gives its owner the right, but not the obligation, to buy or sell a financial asset at a fixed price on or until a specified

FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin-534/fin-534-week-4-quiz-3- str/ For more course tutorials visit www.tutorialoutlet.com Which of the following

### Value of Equity and Per Share Value when there are options and warrants outstanding. Aswath Damodaran

Value of Equity and Per Share Value when there are options and warrants outstanding Aswath Damodaran 1 Equity Value and Per Share Value: A Test Assume that you have done an equity valuation of Microsoft.

### The Behavior of Interest Rates

The Behavior of Interest Rates This lecture examines how the nominal interest rate is determined and what factors influence it. Factors that Affect the Demand for a Particular Asset (The Theory of Portfolio

### PowerPoint. to accompany. Chapter 5. Interest Rates

PowerPoint to accompany Chapter 5 Interest Rates 5.1 Interest Rate Quotes and Adjustments To understand interest rates, it s important to think of interest rates as a price the price of using money. When

### Chapter 6. Interest Rates And Bond Valuation. Learning Goals. Learning Goals (cont.)

Chapter 6 Interest Rates And Bond Valuation Learning Goals 1. Describe interest rate fundamentals, the term structure of interest rates, and risk premiums. 2. Review the legal aspects of bond financing

### Figure 10.1 Listing of Treasury Issues

CHAPER 10 Bond Prices and Yields 10.1 BOND CHARACERISICS Bond Characteristics reasury Notes and Bonds Face or par value Coupon rate Zero coupon bond Compounding and payments Accrued Interest Indenture

### Take-Home Problem Set

Georgia State University Department of Finance MBA 8622 Fall 2001 MBA 8622: Corporation Finance Take-Home Problem Set Instructors: Lalitha Naveen, N. Daniel, C.Hodges, A. Mettler, R. Morin, M. Shrikhande,

### The Term Structure of Interest Rates, Spot Rates, and Yield to Maturity

Chapter 5 How to Value Bonds and Stocks 5A-1 Appendix 5A The Term Structure of Interest Rates, Spot Rates, and Yield to Maturity In the main body of this chapter, we have assumed that the interest rate

### Practice Exam (Solutions)

Practice Exam (Solutions) June 6, 2008 Course: Finance for AEO Length: 2 hours Lecturer: Paul Sengmüller Students are expected to conduct themselves properly during examinations and to obey any instructions

### CHAPTER 13 Capital Structure and Leverage

CHAPTER 13 Capital Structure and Leverage Business and financial risk Optimal capital structure Operating Leverage Capital structure theory 1 What s business risk? Uncertainty about future operating income

### t = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3

MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate

### Bond valuation. Present value of a bond = present value of interest payments + present value of maturity value

Bond valuation A reading prepared by Pamela Peterson Drake O U T L I N E 1. Valuation of long-term debt securities 2. Issues 3. Summary 1. Valuation of long-term debt securities Debt securities are obligations

### Maturity and interest-rate risk

Interest rate risk, page 1 Maturity and interest-rate risk Suppose you buy one of these three bonds, originally selling at a yield to maturity of 8 percent. Yield to One-year 30-year 30-year maturity 8%

### Chapter. Bond Prices and Yields. McGraw-Hill/Irwin. Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Bond Prices and Yields McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Bond Prices and Yields Our goal in this chapter is to understand the relationship

### Chapter 4 Valuing Bonds

Chapter 4 Valuing Bonds MULTIPLE CHOICE 1. A 15 year, 8%, \$1000 face value bond is currently trading at \$958. The yield to maturity of this bond must be a. less than 8%. b. equal to 8%. c. greater than

### MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

ECON 4110: Sample Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Economists define risk as A) the difference between the return on common

### Answers to Review Questions

Answers to Review Questions 1. The real rate of interest is the rate that creates an equilibrium between the supply of savings and demand for investment funds. The nominal rate of interest is the actual

### Yield Curve September 2004

Yield Curve Basics The yield curve, a graph that depicts the relationship between bond yields and maturities, is an important tool in fixed-income investing. Investors use the yield curve as a reference

### VALUATION OF DEBT CONTRACTS AND THEIR PRICE VOLATILITY CHARACTERISTICS QUESTIONS See answers below

VALUATION OF DEBT CONTRACTS AND THEIR PRICE VOLATILITY CHARACTERISTICS QUESTIONS See answers below 1. Determine the value of the following risk-free debt instrument, which promises to make the respective

### CHAPTER 14: BOND PRICES AND YIELDS

CHAPTER 14: BOND PRICES AND YIELDS 1. a. Effective annual rate on 3-month T-bill: ( 100,000 97,645 )4 1 = 1.02412 4 1 =.10 or 10% b. Effective annual interest rate on coupon bond paying 5% semiannually:

### Econ 80H: Introduction

Basic information Course web site: www.econ.ucsc.edu/faculty/elbaum Bernard Elbaum, Economics Dept., Engineering 2, Room 431, ext. 9-4248, email LBAUM@ucsc.edu Office hours, Tu Th 1-2 Econ 80H: Introduction

### Sample Problems Chapter 10

Sample Problems Chapter 10 Title: Cost of Debt 1. Costly Corporation plans a new issue of bonds with a par value of \$1,000, a maturity of 28 years, and an annual coupon rate of 16.0%. Flotation costs associated

### University of Rio Grande Fall 2010

University of Rio Grande Fall 2010 Financial Management (Fin 20403) Practice Questions for Midterm 1 Answers the questions. (Or Identify the letter of the choice that best completes the statement if there

### HP 12C Calculations. 2. If you are given the following set of cash flows and discount rates, can you calculate the PV? (pg.

HP 12C Calculations This handout has examples for calculations on the HP12C: 1. Present Value (PV) 2. Present Value with cash flows and discount rate constant over time 3. Present Value with uneven cash

### Bonds and the Term Structure of Interest Rates: Pricing, Yields, and (No) Arbitrage

Prof. Alex Shapiro Lecture Notes 12 Bonds and the Term Structure of Interest Rates: Pricing, Yields, and (No) Arbitrage I. Readings and Suggested Practice Problems II. Bonds Prices and Yields (Revisited)

### Chapter 2 Present Value

Chapter 2 Present Value Road Map Part A Introduction to finance. Financial decisions and financial markets. Present value. Part B Valuation of assets, given discount rates. Part C Determination of risk-adjusted

### Investment Analysis. Bond Value Bond Yields Bond Pricing Relationships Duration Convexity Bond Options. Bonds part 2. Financial analysis

Bond Value Bond Yields Bond Pricing Relationships Duration Convexity Bond Options Investment Analysis Bonds part 2 Financial analysis - 2 Duration Duration = the average maturity of the bond s promised

### CFA Level -2 Derivatives - I

CFA Level -2 Derivatives - I EduPristine www.edupristine.com Agenda Forwards Markets and Contracts Future Markets and Contracts Option Markets and Contracts 1 Forwards Markets and Contracts 2 Pricing and

### Understanding duration and convexity of fixed income securities. Vinod Kothari

Understanding duration and convexity of fixed income securities Vinod Kothari Notation y : yield p: price of the bond T: total maturity of the bond t: any given time during T C t : D m : Cashflow from

### MBA Financial Management and Markets Spring 2011 Dr. A. Frank Thompson Due: February 28, 2011 Competency Exam 1 Directions: Please answer the

MBA Financial Management and Markets Spring 2011 Dr. A. Frank Thompson Due: February 28, 2011 Competency Exam 1 Directions: Please answer the following 33 questions designed to test your knowledge of the

### C(t) (1 + y) 4. t=1. For the 4 year bond considered above, assume that the price today is 900\$. The yield to maturity will then be the y that solves

Economics 7344, Spring 2013 Bent E. Sørensen INTEREST RATE THEORY We will cover fixed income securities. The major categories of long-term fixed income securities are federal government bonds, corporate

### Chapter 6. The Risk and Term Structure of Interest Rates. 6.1 Risk Structure of Interest Rates

Chapter 6 The Risk and Term Structure of Interest Rates 6.1 Risk Structure of Interest Rates 1) The risk structure of interest rates is A) the structure of how interest rates move over time. B) the relationship

FINC 3630: Advanced Business Finance Additional Practice Problems Accounting For Financial Management 1. Calculate free cash flow for Home Depot for the fiscal year-ended February 1, 2015 (the 2014 fiscal

### 1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises.

1. Solutions to PS 1: 1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises. 7. The bill has a maturity of one-half year, and an annualized

### Chapter 6 Interest rates and Bond Valuation. 2012 Pearson Prentice Hall. All rights reserved. 4-1

Chapter 6 Interest rates and Bond Valuation 2012 Pearson Prentice Hall. All rights reserved. 4-1 Interest Rates and Required Returns: Interest Rate Fundamentals The interest rate is usually applied to

### Calculations for Time Value of Money

KEATMX01_p001-008.qxd 11/4/05 4:47 PM Page 1 Calculations for Time Value of Money In this appendix, a brief explanation of the computation of the time value of money is given for readers not familiar with

### Executive Summary of Finance 430 Professor Vissing-Jørgensen Finance 430-62/63/64, Winter 2011

Executive Summary of Finance 430 Professor Vissing-Jørgensen Finance 430-62/63/64, Winter 2011 Weekly Topics: 1. Present and Future Values, Annuities and Perpetuities 2. More on NPV 3. Capital Budgeting