1. How much interest would the firm pay each year on the simple-interest loan?

2. How much would you write a check for to pay off the loan in one year?

3. What is the monthly payment needed to pay off the fixed-payment loans?

4. What is the current yield for each bond if the current price is:

a. $930.50 for Bond #1?

b. $859.50 for Bond #2?

5. What is the expected yield to maturity for each bond?

a. Bond #1 selling for $930.50?

b. Bond #2 selling for $859.50

6. What is the rate of capital gain if both bonds sell for $900.00 in one year?

a. Bond #1 selling for $930.50 today?

b. Bond #2 selling for $859.50 today?

7. If the Yield to Maturity expected by investors changes to 11%:

a. What will be the market price of Bond #1?

b. What will be the market price of Bond #2?

c. What will be the dollar change in price for Bond #1?

d. What will be the dollar change in price for Bond #2?

e. What will be the percent change in price for Bond #1?

f. What will be the percent change in price for Bond #2?

g. Since the change in expected yield to maturity is the same, why is the amount of

change different between the bonds?

8. If investors holding our 4-year bonds (Bond #1) receive interest income annually for four

years, plus the face value of the bonds at maturity,

a. What will be the total interest earned on the bond over the next four years?

b. What will be the face value received at maturity?

Given the following projected income stream for Bond #1:

c. What is the total cash available over the next four years to the bondholder earning

10%?

d. What is the total cash available over the next four years to the bondholder earning

15%?

e. What is the average annual rate of return for the bondholder earning 10%? (Hint:

Use the market price of 930.50.)

f. What is the average annual rate of return for the bondholder earning 15%? (Hint:

Use the market price of 930.50.)

g. Why does the reinvestment rate affect the annual rate of return for the same

bond?

h. If the expected rate of return on our bonds is 10%, what is the duration of Bond

#1?

9. What is the yield to maturity on the Treasury Bills (a discount bond)?

10. What is the real rate of interest if the nominal rate is 10% and the inflation rate is 3%?

Question 1 Interest Rates, Bond Yields, and Duration CONCEPTS IN THIS CASE: simple loans fixed-payment loans coupon bonds present value yield-to-maturity current yield nominal and real interest rates rate of return capital gain interest-rate and reinvestment risk duration You have been hired to analyze the debt securities of your organization. The firm has outstanding loans and bonds. A quick review of the balance sheet shows the following: 1. How much interest would the firm pay each year on the simple-interest loan? 2. How much would you write a check for to pay off the loan in one year? 3. What is the monthly payment needed to pay off the fixed-payment loans? 4. What is the current yield for each bond if the current price is: a. $930.50 for Bond #1? b. $859.50 for Bond #2? 5. What is the expected yield to maturity for each bond? a. Bond #1 selling for $930.50? b. Bond #2 selling for $859.50 6. What is the rate of capital gain if both bonds sell for $900.00 in one year? a. Bond #1 selling for $930.50 today? b. Bond #2 selling for $859.50 today? 7. If the Yield to Maturity expected by investors changes to 11%: a. What will be the market price of Bond #1? b. What will be the market price of Bond #2? c. What will be the dollar change in price for Bond #1? d. What will be the dollar change in price for Bond #2? e. What will be the percent change in price for Bond #1? f. What will be the percent change in price for Bond #2? g. Since the change in expected yield to maturity is the same, why is the amount of change different between the bonds? 8. If investors holding our 4-year bonds (Bond #1) receive interest income annually for four years, plus the face value of the bonds at maturity, a. What will be the total interest earned on the bond over the next four years? b. What will be the face value received at maturity? Given the following projected income stream for Bond #1: c. What is the total cash available over the next four years to the bondholder earning 10%? d. What is the total cash available over the next four years to the bondholder earning 15%? e. What is the average annual rate of return for the bondholder earning 10%? (Hint: Use the market price of 930.50.) f. What is the average annual rate of return for the bondholder earning 15%? (Hint: Use the market price of 930.50.) g. Why does the reinvestment rate affect the annual rate of return for the same bond? h. If the expected rate of return on our bonds is 10%, what is the duration of Bond #1? 9. What is the yield to maturity on the Treasury Bills (a discount bond)? 10. What is the real rate of interest if the nominal rate is 10% and the inflation rate is 3%? Question 2 The Behavior of Interest Rates CONCEPTS IN THIS CASE effect of interest-rate changes Fisher effect bond values expected return equation market equilibrium loanable funds framework asset market approach liquidity preference framework demand and supply curves Your company is interested in analyzing the behavior of interest rates and the models used to predict interest rates in the future. As an initial project in this area, you have been assigned the task of creating a presentation that will show the top management team assigned this project the basics of what affects interest rates and how equilibrium prices change over time. The better your presentation to this group, the more likely you are to become a voting member of the team. To begin your work, you have decided to identify a series of questions that you think this team will ask, including tables and graphs that will satisfy their concerns about the final presentation to the CFO. You decide to start by answering the following questions, assuming that the face value of a discount bond is $1000 and the time to maturity is one year. 1. What is the expected return for this bond if the market price is a. $800? b. $850? c. $900? d. $950? e. $1000 2. If the market-clearing price (market equilibrium) of this bond has a return of 20% what is the market price where the quantity demanded equals the quantity supplied? (Hint: Use the same expected return equation, solve for P.) 3. Which factors would cause the demand curve for bonds to shift? 4. Which factors would cause the supply curve for bonds to shift? 5. Explain what the Fisher effect is and how it would be reflected in rising interest rates. 6. Explain the meaning and differences between the loanable funds framework and the liquidity preference framework in estimating the equilibrium interest rate. (Include the effects of changes in income, price levels, and expected inflation.) 7. Predict the supply and demand changes for bonds and money that usually occur with the following events: Bonds: a. business cycle expansion with growing wealth b. expected rise in interest rates c. increase in expected rate of inflation d. increased risk for bonds e. increased liquidity for bonds f. higher government deficits Money: g. increase in level of income h. rise in the price level i. income rising during an expansion j. expected inflation increases