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


 Blaise Pierce
 6 years ago
 Views:
Transcription
1 VALUATION OF DEBT CONTRACTS AND THEIR PRICE VOLATILITY CHARACTERISTICS QUESTIONS See answers below 1. Determine the value of the following riskfree debt instrument, which promises to make the respective payments when the appropriate annual rates are as shown in the last column. Year Cash Payment Appropriate Annual Rate 1 $15, % 2 17, , , For each of the following, calculate the price per $1,000 of par value assuming semiannual coupon payments. Coupon Bond Years to Rate Required Maturity Yield A 8% 9 7% B C D Consider a bond selling at par ($100) with a coupon rate of 6% and 10 years to maturity. a. What is the price of this bond if the required yield is 15%? b. What is the price of this bond if the required yield increases from 15% to 16%, and by what percentage did the price of this bond change? c. What is the price of this bond if the required yield is 5%? d. What is the price of this bond if the required yield increases from 5% to 6%, and by what percentage did the price of this bond change? e. From your answers to parts (b) and (d) what can you say about the relative price volatility of a bond in high compared to low interest rate environments? 5. Suppose you purchased a debt obligation 3 years ago at its par value of $100,000.The market price of this debt obligation today is $90,000. What are some of the reasons why the price of this debt obligation could have declined since you purchased it 3 years ago? 9. A portfolio manager is considering buying two bonds. Bond A matures in 3 years and has a coupon rate of 10% payable semiannually. Bond B, of the same credit quality, matures in 10 years and has a coupon rate of 12% payable semiannually. Both bonds are priced at par. 1
2 a. Suppose the portfolio manager plans to hold the bond that is purchased for 3 years. Which would be the best bond for the portfolio manager to purchase? b. Suppose the portfolio manager plans to hold the bond that is purchased for 6 years instead of 3 years. In this case, which would be the best bond for the portfolio manager to purchase? c. Suppose that the portfolio manager is managing the assets of a life insurance company that issued a 5year guaranteed investment contract (GIC). The interest rate that the life insurance company agreed to pay is 9% on a semiannual basis. Which of the two bonds should the portfolio manager purchase to assure that the GIC payments will be satisfied and that a profit will be generated by the life insurance company? 10. What is meant by reinvestment risk when purchasing a bond? 11. Can you tell from the following information which of the three bonds will have the greatest price volatility, assuming each is trading to offer the same yield to maturity? Coupon Bond Rate Maturity X 8% 9 years Y Z Calculate the requested measures for bonds A and B (assume each bond pays interest semiannually): A B Coupon 8% 9% Yield to maturity 8% 8% Maturity (in 2 5 years) Par Price a. Calculate the duration for the two bonds by changing the yield up and down 25 basis points. b. Calculate the duration for the two bonds by changing the yield up and down by 10 basis points. c. Compare your answers to parts (a) and (b). d. Calculate the Macaulay duration for the two bonds. e. Calculate the modified duration for the two bonds. f. Compare the modified duration for the two bonds computed in parts (e) and (a). 14. Which of the following bonds will have the larger price change for a 50 basis point change in yield? Bond Duration Price 2
3 E 7 50 F What is the difference between modified duration and effective duration? 16. What is assumed about how the yield curve changes when using duration? 17. An investor is discussing the duration of a highly complex bond with his broker. The broker tells the investor that the duration of this bond is negative 5. The investor is confused about the negative value and tells the broker that the figure must be in error because the duration is always positive because it is some type of weighted average of time of the cash flows. Comment. 18. As a portfolio manager, you present a report to a client. The report indicates the duration of each security in the portfolio. One of the securities has a maturity of 15 years but duration of 25. The client believes that the report contains an error because she believes that the duration cannot be greater than the security's maturity. What would be your response to this client? 19. A strategy called immunization is used by institutional investors to protect a portfolio against an adverse change in interest rates. Basically this strategy seeks to offset interest rate risk and reinvestment risk. Why do these two risks offset each other to a certain extent when interest rates change? 3
4 VALUATION OF DEBT CONTRACTS AND THEIR PRICE VOLATILITY CHARACTERISTICS ANSWERS TO QUESTIONS 1. In terms of the notation used in the chapter: a 1 = $15,000 r 1 =.080 a 2 = $17,000 r 2 =.085 a 3 = $20,000 r 3 =.090 a 4 = $21,000 r 4 =.095 P 0 = 15, 000 (1.080) 17, (1.080)(1.085) 20, (1.080)(1.085)(1.090) 21, (1.080)(1.085)(1.090)(1.095) = $13, $14, $15, $15, = $59, The price of bond A is $1,065.95; the price of bond B is $1,000, price of bond C is $ and price of bond D (zero coupon) is $ The original bond yield is 6 percent. a. If required yield is 15%, the price of bond will be b. When yield increases to 16%, price of bond will decrease to , and percentage decrease is c. If the required yield is 5%, the price of bond will be d. If required yield increases from 5% to 6%, we are back to the original data, and the selling price will be 100. The decrease in price is ( ) = 7.17%. e. The percentage change observed in prices of bonds in (b) and (d) suggest that relative price volatility is more when initial yield is low (part d) and less when initial level is high (part b). 5. The price of this debt obligation can change over time for any one of the following reasons: (1) a rise in the level of interest rates in the economy over the past three years; (2) an increase in the required yield due to a change in the yield spread between nontreasury and Treasury securities; (3) a decline in the perceived credit quality of the debtor. 9. a. It must be stressed that there is no way to determine which bond will provide the best return. Since these bonds are priced at par, the yield to maturity for bonds A and B is 10% and 12%, respectively. However, yield to maturity tells us absolutely nothing about the dollars that will be generated from holding each bond. The number of dollars that will be received from investing in Bond A depends on the reinvestment rate over the three years. Thus for this bond, there is reinvestment risk. For Bond B, the dollars that will be realized depend on the yield for 7year bonds three years from now (because Bond B will be a 7year bond at that time). The portfolio manager is 4
5 exposed to both reinvestment risk and interest rate (or price) risk. b. If the holding period is six years rather than three years, the answer is the same as in (a); it is not possible to determine a priori which bond will provide the best return. The dollars received from investing in Bond A will not only depend on the reinvestment rates over the first three years, but also reinvestment rates from years three to six. c. Once again, it is not possible to lock in a profit or spread with either bond because of reinvestment risk for both bonds and interest rate (or price risk) for Bond B. As an aside, this fundamental principle has been overlooked by many financial institutions who believe that a "yield" indicates the return that will be realized. 10. The concept of yield to maturity assumes that the investor will realize the yield to maturity that is calculated at the time of purchase only if (1) all the coupon payments can be reinvested at the yield to maturity, and (2) the bond is held to maturity. With respect to the first assumption, the risk that an investor faces is that future interest rates at which the coupon can be reinvested will be less than the yield to maturity at the time the bond is purchased. This risk is reinvestment risk. 11. From the properties of price volatility, it is not possible to say which has the greatest price volatility. An unambiguous answer requires that both the coupon rate be lower and the maturity be greater than the other bonds. The purpose of this question is to demonstrate to students the need to quantify price volatility, i.e., the factors that affect price volatility are insufficient to indicate relative price volatility. 12. Note that a 25 bp increase in yield translates into a.125% increase in semiannual yield when calculating prices. Thus, in this case, an increase in 25 bp gives a semiannual yield of 4.125% and a decrease leads to a yield of 3.875%; a 10% bp increase gives a yield of 4.05% and a decrease leads to a yield of 3.95%. To estimate duration using Equation 18.10, however, dy must NOT be adjusted. In the text examples, the values in Table 181 are found using semiannual rates, where dy is applied to the annual equivalent  a 50 basis point increase in rates, from 9%, would give a semiannual yield of 4.75%. Part a For Bond A in part a of the question, the duration is found using Bond A N = 4, I = 8/2 = 4, FV = 100, PMT = 4, cpt PV = 100 N = 4, I = 8.25/2 =4.125, FV = 100, PMT = 4, cpt PV = N = 4, I = 7.75/2 =, FV = 100, PMT = 4, cpt PV = Equation 18.10, where V + is , V  is , dy is , and V 0 is
6 Duration Part b Bond A N = 4, I = 8/2 = 4, FV = 100, PMT = 4, cpt PV = 100 N = 4, I = 8.1/2 =4.05, FV = 100, PMT = 4, cpt PV = N = 4, I = 7.9/2 =3.95, FV = 100, PMT = 4, cpt PV = Equation 18.10, where V + is 99.5, V  is , dy is , and V 0 is 100. Duration Bond A Bond B a. Duration with 25 bp change b. D with 10 bp change c. There was a much larger change in duration for the bond which was trading above par, as should be expected. d. Macaulay duration for Bond A is found using the following equation D (1) $ 40 (1.04 ) (2 ) $ 40 (1.04 ) 2 $ 1, 000 (3 ) $ 40 (1.04 ) 3 ( 4 ) $ 1, 040 (1.04 ) semiannual periods This amount would be annual periods. The Macaulay duration for Bond B is on a semiannual basis, or annual periods. e. The modified duration for Bond A is modified duration = Macaulay duration 1 + yield For Bond B, the modified duration is
7 f. Modified duration appears to track closely with the numbers produced in part a of the question. 14. Bond E will have 3.5 percentage change in price, while bond F will have a 2.5 percentage change in its price. However, the dollar amount of price change for bond F is larger than bond E. 15. Modified duration doesn't take into account changes in the bond value due to embedded options. Effective duration is flexible enough to allow analysts to reflect options and their exercise in the value of the bond. 16. When using any measure of duration, there is an implicit assumption that the yield curve shifts in parallel. 17. Duration describes how the value of a security changes when rates change, or what our best guess of that change will be. Measures such as the Macaulay duration are required to be positive because of the way that they are derived, but duration itself can take any value. One example of securities which have a negative duration is interestonly securities derived from mortgage portfolios. The value of these securities falls when rates fall due to the fact that homeowners will prepay their mortgages and the income of the portfolio will fall, lowering the expected cash flows from the pool of mortgages over time. 18. When the client believes that there is an error in your report, he is referring to the concept of Macaulay duration as some measure of the weighted average life of a bond. Thus he is right that a bond with a maturity of 15 years cannot have a Macaulay duration of 25. The duration of the bond, however, can take on any value. In this case, it means that the bond in question will be more sensitive to changes in rates than bonds with a 15 year term. 19. It is possible to create a portfolio of debt securities where the loss in one component of the return (for example, reinvestment loss) is offset by a gain in the other (for example, price gain). Particularly, if a portfolio is constructed such that its duration is equal to the investment horizon, it may be possible to offset interest rate risk (price risk) and reinvestment risk. A rise in market interest rates will lead to a loss in the market value of the portfolio, but a gain on account of higher returns earned on reinvested coupons. A fall in market interest rates will lead to a gain the market value of the portfolio, but a loss on account of lower returns earned on reinvested coupons. Thus the portfolio is "immunized" against changes in interest rates. 7
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
More informationFixed Income: Practice Problems with Solutions
Fixed Income: Practice Problems with Solutions Directions: Unless otherwise stated, assume semiannual payment on bonds.. A 6.0 percent bond matures in exactly 8 years and has a par value of 000 dollars.
More informationChapter 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 10year 7% coupon Treasury bond that pays interest annually. a. You have been told that the yield to maturity
More informationLOS 56.a: Explain steps in the bond valuation process.
The following is a review of the Analysis of Fixed Income Investments principles designed to address the learning outcome statements set forth by CFA Institute. This topic is also covered in: Introduction
More informationAmerican Options and Callable Bonds
American Options and Callable Bonds American Options Valuing an American Call on a Coupon Bond Valuing a Callable Bond Concepts and Buzzwords Interest Rate Sensitivity of a Callable Bond exercise policy
More information2. Determine the appropriate discount rate based on the risk of the security
Fixed Income Instruments III Intro to the Valuation of Debt Securities LOS 64.a Explain the steps in the bond valuation process 1. Estimate the cash flows coupons and return of principal 2. Determine the
More informationChapter. Bond Prices and Yields. McGrawHill/Irwin. Copyright 2008 by The McGrawHill Companies, Inc. All rights reserved.
Chapter Bond Prices and Yields McGrawHill/Irwin Copyright 2008 by The McGrawHill Companies, Inc. All rights reserved. Bond Prices and Yields Our goal in this chapter is to understand the relationship
More informationI. Readings and Suggested Practice Problems. II. Risks Associated with DefaultFree Bonds
Prof. Alex Shapiro Lecture Notes 13 Bond Portfolio Management I. Readings and Suggested Practice Problems II. Risks Associated with DefaultFree Bonds III. Duration: Details and Examples IV. Immunization
More informationTIME VALUE OF MONEY PROBLEM #5: ZERO COUPON BOND
TIME VALUE OF MONEY PROBLEM #5: ZERO COUPON BOND Professor Peter Harris Mathematics by Dr. Sharon Petrushka Introduction This assignment will focus on using the TI  83 to calculate the price of a Zero
More informationAlliance Consulting BOND YIELDS & DURATION ANALYSIS. Bond Yields & Duration Analysis Page 1
BOND YIELDS & DURATION ANALYSIS Bond Yields & Duration Analysis Page 1 COMPUTING BOND YIELDS Sources of returns on bond investments The returns from investment in bonds come from the following: 1. Periodic
More informationCHAPTER 14: BOND PRICES AND YIELDS
CHAPTER 14: BOND PRICES AND YIELDS 1. a. Effective annual rate on 3month Tbill: ( 100,000 97,645 )4 1 = 1.02412 4 1 =.10 or 10% b. Effective annual interest rate on coupon bond paying 5% semiannually:
More informationCHAPTER 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
More informationCHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS
1 CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS (f) 1 The three step valuation process consists of 1) analysis of alternative economies and markets, 2) analysis of alternative industries
More informationAsset Valuation Debt Investments: Analysis and Valuation
Asset Valuation Debt Investments: Analysis and Valuation Joel M. Shulman, Ph.D, CFA Study Session # 15 Level I CFA CANDIDATE READINGS: Fixed Income Analysis for the Chartered Financial Analyst Program:
More informationCanadian Life Insurance Company Asset/Liability Management Summary Report as at: 31Jan08 interest rates as of: 29Feb08 Run: 2Apr08 20:07 Book
Canadian Life Insurance Company Asset/Liability Management Summary Report as at: 31Jan08 interest rates as of: 29Feb08 Run: 2Apr08 20:07 Book Book Present Modified Effective Projected change in net present
More informationChapter 5: Valuing Bonds
FIN 302 Class Notes Chapter 5: Valuing Bonds What is a bond? A longterm debt instrument A contract where a borrower agrees to make interest and principal payments on specific dates Corporate Bond Quotations
More informationExam 1 Morning Session
91. A high yield bond fund states that through active management, the fund s return has outperformed an index of Treasury securities by 4% on average over the past five years. As a performance benchmark
More informationCHAPTER 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
More informationCHAPTER 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
More informationUnderstanding 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
More informationYou just paid $350,000 for a policy that will pay you and your heirs $12,000 a year forever. What rate of return are you earning on this policy?
1 You estimate that you will have $24,500 in student loans by the time you graduate. The interest rate is 6.5%. If you want to have this debt paid in full within five years, how much must you pay each
More informationTIME VALUE OF MONEY #6: TREASURY BOND. Professor Peter Harris Mathematics by Dr. Sharon Petrushka. Introduction
TIME VALUE OF MONEY #6: TREASURY BOND Professor Peter Harris Mathematics by Dr. Sharon Petrushka Introduction This problem assumes that you have mastered problems 15, which are prerequisites. In this
More informationClick Here to Buy the Tutorial
FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin534/fin534week4quiz3 str/ For more course tutorials visit www.tutorialoutlet.com Which of the following
More informationA) 1.8% B) 1.9% C) 2.0% D) 2.1% E) 2.2%
1 Exam FM Questions Practice Exam 1 1. Consider the following yield curve: Year Spot Rate 1 5.5% 2 5.0% 3 5.0% 4 4.5% 5 4.0% Find the four year forward rate. A) 1.8% B) 1.9% C) 2.0% D) 2.1% E) 2.2% 2.
More informationTopics in Chapter. Key features of bonds Bond valuation Measuring yield Assessing risk
Bond Valuation 1 Topics in Chapter Key features of bonds Bond valuation Measuring yield Assessing risk 2 Determinants of Intrinsic Value: The Cost of Debt Net operating profit after taxes Free cash flow
More informationBond 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 longterm debt securities 2. Issues 3. Summary 1. Valuation of longterm debt securities Debt securities are obligations
More informationCHAPTER 16: MANAGING BOND PORTFOLIOS
CHAPTER 16: MANAGING BOND PORTFOLIOS PROBLEM SETS 1. While it is true that shortterm rates are more volatile than longterm rates, the longer duration of the longerterm bonds makes their prices and their
More informationBond Valuation. What is a bond?
Lecture: III 1 What is a bond? Bond Valuation When a corporation wishes to borrow money from the public on a longterm basis, it usually does so by issuing or selling debt securities called bonds. A bond
More informationReview for Exam 1. Instructions: Please read carefully
Review for Exam 1 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems covering chapter 1, 2, 3, 4, 14, 16. Questions in the multiple choice section will
More informationFinance Homework Julian Vu May 28, 2008
Finance Homework Julian Vu May 28, 2008 Assignment: p. 2829 Problems 11 and 12 p. 145147 Questions 42, 43, and 44, and Problems 41, 42, 43, and 413 P11 A Treasury Bond that matures in 10 years
More informationChapter 9 Bonds and Their Valuation ANSWERS TO SELECTED ENDOFCHAPTER QUESTIONS
Chapter 9 Bonds and Their Valuation ANSWERS TO SELECTED ENDOFCHAPTER QUESTIONS 91 a. A bond is a promissory note issued by a business or a governmental unit. Treasury bonds, sometimes referred to as
More informationChapter 6 APPENDIX B. The Yield Curve and the Law of One Price. Valuing a Coupon Bond with ZeroCoupon Prices
196 Part Interest Rates and Valuing Cash Flows Chapter 6 APPENDIX B The Yield Curve and the Law of One Price Thus far, we have focused on the relationship between the price of an individual bond and its
More informationANSWERS TO STUDY QUESTIONS
ANSWERS TO STUDY QUESTIONS Chapter 17 17.1. The details are described in section 17.1.1. 17.3. Because of its declining payment pattern, a CAM would be most useful in an economy with persistent deflation
More informationFinancialInstitutions Management. Solutions 1. 6. A financial institution has the following market value balance sheet structure:
FIN 683 Professor Robert Hauswald FinancialInstitutions Management Kogod School of Business, AU Solutions 1 Chapter 7: Bank Risks  Interest Rate Risks 6. A financial institution has the following market
More informationWeekly Relative Value
Back to Basics Identifying Value in Fixed Income Markets As managers of fixed income portfolios, one of our key responsibilities is to identify cheap sectors and securities for purchase while avoiding
More informationCHAPTER 8 INTEREST RATES AND BOND VALUATION
CHAPTER 8 INTEREST RATES AND BOND VALUATION Answers to Concept Questions 1. No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Longterm Treasury securities have substantial
More informationHow To Calculate Bond Price And Yield To Maturity
CHAPTER 10 Bond Prices and Yields Interest rates go up and bond prices go down. But which bonds go up the most and which go up the least? Interest rates go down and bond prices go up. But which bonds go
More informationissue brief Duration Basics January 2007 Duration is a term used by fixedincome investors, California Debt and Investment Advisory Commission
issue brief California Debt and Investment Advisory Commission # 0610 January 2007 Duration Basics Introduction Duration is a term used by fixedincome investors, financial advisors, and investment advisors.
More informationZeroCoupon Bonds (Pure Discount Bonds)
ZeroCoupon Bonds (Pure Discount Bonds) The price of a zerocoupon bond that pays F dollars in n periods is F/(1 + r) n, where r is the interest rate per period. Can meet future obligations without reinvestment
More informationCHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES
CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES 1. Expectations hypothesis. The yields on longterm bonds are geometric averages of present and expected future short rates. An upward sloping curve is
More informationFNCE 301, Financial Management H Guy Williams, 2006
REVIEW We ve used the DCF method to find present value. We also know shortcut methods to solve these problems such as perpetuity present value = C/r. These tools allow us to value any cash flow including
More informationVALUATION OF FIXED INCOME SECURITIES. Presented By Sade Odunaiya Partner, Risk Management Alliance Consulting
VALUATION OF FIXED INCOME SECURITIES Presented By Sade Odunaiya Partner, Risk Management Alliance Consulting OUTLINE Introduction Valuation Principles Day Count Conventions Duration Covexity Exercises
More informationFinance 350: Problem Set 6 Alternative Solutions
Finance 350: Problem Set 6 Alternative Solutions Note: Where appropriate, the final answer for each problem is given in bold italics for those not interested in the discussion of the solution. I. Formulas
More informationManual for SOA Exam FM/CAS Exam 2.
Manual for SOA Exam FM/CAS Exam 2. Chapter 6. Variable interest rates and portfolio insurance. c 2009. Miguel A. Arcones. All rights reserved. Extract from: Arcones Manual for the SOA Exam FM/CAS Exam
More informationInvestments Analysis
Investments Analysis Last 2 Lectures: Fixed Income Securities Bond Prices and Yields Term Structure of Interest Rates This Lecture (#7): Fixed Income Securities Term Structure of Interest Rates Interest
More informationChapter 6 Interest Rates and Bond Valuation
Chapter 6 Interest Rates and Bond Valuation Solutions to Problems P61. P62. 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
More informationBond Valuation. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Bond Valuation: An Overview
Bond Valuation FINANCE 350 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University 1 Bond Valuation: An Overview Bond Markets What are they? How big? How important? Valuation
More informationHow To Sell A Callable Bond
1.1 Callable bonds A callable bond is a fixed rate bond where the issuer has the right but not the obligation to repay the face value of the security at a preagreed value prior to the final original maturity
More informationMaturity targeted Bond Funds Lock in Anticipated Yield to Maturity
Winter 11 Maturity targeted Bond Funds Lock in Anticipated Yield to Maturity How fund dinvestors can benefit fitfrom the permanence and definition of portfolios of bonds, held to their maturity. Matthew
More informationProblem Set: Annuities and Perpetuities (Solutions Below)
Problem Set: Annuities and Perpetuities (Solutions Below) 1. If you plan to save $300 annually for 10 years and the discount rate is 15%, what is the future value? 2. If you want to buy a boat in 6 years
More informationChapter 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
More informationMath of Finance. Texas Association of Counties January 2014
Math of Finance Texas Association of Counties January 2014 Money Market Securities Sample Treasury Bill Quote*: N Bid Ask Ask Yld 126 4.86 4.85 5.00 *(Yields do not reflect current market conditions) Bank
More informationCHAPTER 10 BOND PRICES AND YIELDS
CHAPTER 10 BOND PRICES AND YIELDS 1. a. Catastrophe bond. Typically issued by an insurance company. They are similar to an insurance policy in that the investor receives coupons and par value, but takes
More informationBond Valuation. Chapter 7. Example (coupon rate = r d ) Bonds, Bond Valuation, and Interest Rates. Valuing the cash flows
Bond Valuation Chapter 7 Bonds, Bond Valuation, and Interest Rates Valuing the cash flows (1) coupon payment (interest payment) = (coupon rate * principal) usually paid every 6 months (2) maturity value
More informationFINC 3630: Advanced Business Finance Additional Practice Problems
FINC 3630: Advanced Business Finance Additional Practice Problems Accounting For Financial Management 1. Calculate free cash flow for Home Depot for the fiscal yearended February 1, 2015 (the 2014 fiscal
More informationChapter 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
More informationBond Valuation. Capital Budgeting and Corporate Objectives
Bond Valuation Capital Budgeting and Corporate Objectives Professor Ron Kaniel Simon School of Business University of Rochester 1 Bond Valuation An Overview Introduction to bonds and bond markets» What
More informationAmerican Funds Insurance Series. U.S. Government/ AAARated Securities Fund. Summary prospectus Class 3 shares May 1, 2016
American Funds Insurance Series U.S. Government/ AAARated Securities Fund Summary prospectus Class 3 shares May 1, 2016 Before you invest, you may want to review the fund s prospectus and statement of
More informationExam 1 Sample Questions
Exam 1 Sample Questions 1. Asset allocation refers to. A. the allocation of the investment portfolio across broad asset classes B. the analysis of the value of securities C. the choice of specific assets
More informationInterest 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
More informationANALYSIS OF FIXED INCOME SECURITIES
ANALYSIS OF FIXED INCOME SECURITIES Valuation of Fixed Income Securities Page 1 VALUATION Valuation is the process of determining the fair value of a financial asset. The fair value of an asset is its
More informationMANAGING INTEREST RATE RISK IN A FIXED INCOME PORTFOLIO
CALIFORNIA DEBT & INVESTMENT ADVISORY COMMISSION MANAGING INTEREST RATE RISK IN A FIXED INCOME PORTFOLIO SEPTEMBER 2008 CDIAC #0811 INTRODUCTION California statute requires the governing body of local
More informationUnderstanding Fixed Income
Understanding Fixed Income 2014 AMP Capital Investors Limited ABN 59 001 777 591 AFSL 232497 Understanding Fixed Income About fixed income at AMP Capital Our global presence helps us deliver outstanding
More informationCHAPTER 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)
More information3. If an individual investor buys or sells a currently owned stock through a broker, this is a primary market transaction.
Spring 2012 Finance 3130 Sample Exam 1A Questions for Review 1. The form of organization for a business is an important issue, as this decision has very significant effect on the income and wealth of the
More informationManaging the Investment Portfolio
Managing the Investment Portfolio GSBC Executive Development Institute April 26, 2015 Portfolio Purpose & Objectives Tale of Two Balance Sheets o Components of Core Balance Sheet Originated loans Retail
More informationThe cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction
The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal
More informationAnswers 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
More informationAnalysis of Deterministic Cash Flows and the Term Structure of Interest Rates
Analysis of Deterministic Cash Flows and the Term Structure of Interest Rates Cash Flow Financial transactions and investment opportunities are described by cash flows they generate. Cash flow: payment
More informationFinancialInstitutions Management. Solutions 6
Solutions 6 Chapter 25: Loan Sales 2. A bank has made a threeyear $10 million loan that pays annual interest of 8 percent. The principal is due at the end of the third year. a. The bank is willing to
More informationFixed Income Arbitrage
Risk & Return Fixed Income Arbitrage: Nickels in Front of a Steamroller by Jefferson Duarte Francis A. Longstaff Fan Yu Fixed Income Arbitrage Broad set of marketneutral strategies intended to exploit
More informationDuration and convexity
Duration and convexity Prepared by Pamela Peterson Drake, Ph.D., CFA Contents 1. Overview... 1 A. Calculating the yield on a bond... 4 B. The yield curve... 6 C. Optionlike features... 8 D. Bond ratings...
More informationGlobal Financial Management
Global Financial Management Bond Valuation Copyright 999 by Alon Brav, Campbell R. Harvey, Stephen Gray and Ernst Maug. All rights reserved. No part of this lecture may be reproduced without the permission
More informationPractice Set #2 and Solutions.
FIN672 Securities Analysis & Portfolio Management Professor Michel A. Robe Practice Set #2 and Solutions. What to do with this practice set? To help MBA students prepare for the assignment and the exams,
More informationKey Concepts and Skills. Multiple Cash Flows Future Value Example 6.1. Chapter Outline. Multiple Cash Flows Example 2 Continued
6 Calculators Discounted Cash Flow Valuation Key Concepts and Skills Be able to compute the future value of multiple cash flows Be able to compute the present value of multiple cash flows Be able to compute
More informationCredit Derivatives. Southeastern Actuaries Conference. Fall Meeting. November 18, 2005. Credit Derivatives. What are they? How are they priced?
1 Credit Derivatives Southeastern Actuaries Conference Fall Meeting November 18, 2005 Credit Derivatives What are they? How are they priced? Applications in risk management Potential uses 2 2 Credit Derivatives
More informationChapter 22 Credit Risk
Chapter 22 Credit Risk May 22, 2009 20.28. Suppose a 3year corporate bond provides a coupon of 7% per year payable semiannually and has a yield of 5% (expressed with semiannual compounding). The yields
More informationBasic Financial Tools: A Review. 3 n 1 n. PV FV 1 FV 2 FV 3 FV n 1 FV n 1 (1 i)
Chapter 28 Basic Financial Tools: A Review The building blocks of finance include the time value of money, risk and its relationship with rates of return, and stock and bond valuation models. These topics
More informationBUSINESS FINANCE (FIN 312) Spring 2008
BUSINESS FINANCE (FIN 312) Spring 2008 Assignment 3 Instructions: please read carefully You can either do the assignment by yourself or work in a group of no more than two. You should show your work how
More informationCHAPTER 8 INTEREST RATES AND BOND VALUATION
CHAPTER 8 INTEREST RATES AND BOND VALUATION Solutions to Questions and Problems 1. The price of a pure discount (zero coupon) bond is the present value of the par value. Remember, even though there are
More informationChapter 3 Fixed Income Securities
Chapter 3 Fixed Income Securities Road Map Part A Introduction to finance. Part B Valuation of assets, given discount rates. Fixedincome securities. Stocks. Real assets (capital budgeting). Part C Determination
More informationMortgageBacked Securities. Mortgage Loans Passthroughs and Prepayments CMOs Analysis of MBS Pricing and Convexity
MortgageBacked Securities/1 AssetBacked Securities MortgageBacked Securities Prof. Ian Giddy Stern School of Business New York University Mortgages and MBS Mortgage Loans Passthroughs and Prepayments
More informationChapter 6 Valuing Bonds. (1) coupon payment  interest payment (coupon rate * principal)  usually paid every 6 months.
Chapter 6 Valuing Bonds Bond Valuation  value the cash flows (1) coupon payment  interest payment (coupon rate * principal)  usually paid every 6 months. (2) maturity value = principal or par value
More informationChapter Nine Selected Solutions
Chapter Nine Selected Solutions 1. What is the difference between book value accounting and market value accounting? How do interest rate changes affect the value of bank assets and liabilities under the
More informationPrepared by: Dalia A. Marafi Version 2.0
Kuwait University College of Business Administration Department of Finance and Financial Institutions Using )Casio FC200V( for Fundamentals of Financial Management (220) Prepared by: Dalia A. Marafi Version
More informationC H A P T E R Investing in Bonds 441
Investing in Bonds C H A P T E R 16 Tom scratched his head for a moment. This was something entirely new to him. His broker was recommending a car and junk? And who were all these people that his broker
More informationWhat Does a Mutual Fund s Term Tell Investors? by Geng Deng, Craig McCann and Edward O Neal 1
Introduction What Does a Mutual Fund s Term Tell Investors? by Geng Deng, Craig McCann and Edward O Neal 1 In a previous article, we highlighted a flaw in the average credit quality statistic frequently
More informationChapter 4 Bonds and Their Valuation ANSWERS TO ENDOFCHAPTER QUESTIONS
Chapter 4 Bonds and Their Valuation ANSWERS TO ENDOFCHAPTER QUESTIONS 41 a. A bond is a promissory note issued by a business or a governmental unit. Treasury bonds, sometimes referred to as government
More information1. The Purdue Life Insurance Company has two assets and two liabilities.
Chapter 9, Section 1 1. The Purdue Life Insurance Company has two assets and two liabilities. The assets are: a. A 5 year par value bond with a maturity value of 100,000. The bond pays annual coupons at
More informationCHAPTER 6 ASSETLIABILITY MANAGEMENT: DETERMINING AND MEASURING INTEREST RATES AND CONTROLLING INTERESTSENSITIVE AND DURATION GAPS
CHAPTER 6 ASSETLIABILITY MANAGEMENT: DETERMINING AND MEASURING INTEREST RATES AND CONTROLLING INTERESTSENSITIVE AND DURATION GAPS Goals of This Chapter: The purpose of this chapter is to explore the
More informationSAMPLE MIDTERM QUESTIONS
SAMPLE MIDTERM QUESTIONS William L. Silber HOW TO PREPARE FOR THE MID TERM: 1. Study in a group 2. Review the concept questions in the Before and After book 3. When you review the questions listed below,
More informationMathematics. Rosella Castellano. Rome, University of Tor Vergata
and Loans Mathematics Rome, University of Tor Vergata and Loans Future Value for Simple Interest Present Value for Simple Interest You deposit E. 1,000, called the principal or present value, into a savings
More informationChapter 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.
More informationModule 5: Interest concepts of future and present value
Page 1 of 23 Module 5: Interest concepts of future and present value Overview In this module, you learn about the fundamental concepts of interest and present and future values, as well as ordinary annuities
More informationTrading the Yield Curve. Copyright 19992006 Investment Analytics
Trading the Yield Curve Copyright 19992006 Investment Analytics 1 Trading the Yield Curve Repos Riding the Curve Yield Spread Trades Coupon Rolls Yield Curve Steepeners & Flatteners Butterfly Trading
More informationExercise 1 for Time Value of Money
Exercise 1 for Time Value of Money MULTIPLE CHOICE 1. Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines are useful for visualizing
More informationFinal Exam Practice Set and Solutions
FIN469 Investments Analysis Professor Michel A. Robe Final Exam Practice Set and Solutions What to do with this practice set? To help students prepare for the final exam, three practice sets with solutions
More information Short term notes (bonds) Maturities of 14 years  Mediumterm notes/bonds Maturities of 510 years  Longterm bonds Maturities of 1030 years
Contents 1. What Is A Bond? 2. Who Issues Bonds? Government Bonds Corporate Bonds 3. Basic Terms of Bonds Maturity Types of Coupon (Fixed, Floating, Zero Coupon) Redemption Seniority Price Yield The Relation
More informationChapter Review and SelfTest Problems. Answers to Chapter Review and SelfTest Problems
236 PART THREE Valuation of Future Cash Flows Chapter Review and SelfTest Problems 7.1 Bond Values A Microgates Industries bond has a 10 percent coupon rate and a $1,000 face value. Interest is paid semiannually,
More information