1.Bob received a new 5-weight, 9 foot Sage XP fly rod for Christmas. The rod cost his wife $500 at the local fly shop. The only problem is Bob already has a 5-weight, 9 foot, Sage XP fly rod. Bob is trying to decide whether to return the rod to the store, which involves driving out to the suburbs, a trip that will take 1.5 hours roundtrip. Alternatively, he can keep the rod and give it to his college age son, Little Bob, for his birthday, which is in 5 months. Bob does not expect the price of the rod to change over the next year. If the annual interest rate is 6%, how high does the value of Bobs time (per hour) have to be for the trip to the mall to be zero NPV? He will have to go to the mall in 5 months anyway, to shop for a birthday present for McKenzie, Little Bobs twin sister, but going now would be a special trip. (Ignore the cost of gas for the trip).

Show step-by-step how you get to your solution.

2.The following nominal default-free bonds are traded in a well functioning capital market today:

Bond Type Face Value Coupon Maturity Price A Zero Coupon Bond $100 - 1 year $95.00 B Coupon Bond $100 6% 2 years $97.92 C Coupon Bond $100 10% 3 years $104.00

1. Assuming that all the bonds make only annual payments, what discount factors (DF1, DF2, DF3) are embedded in these prices? Show all your calculations.

2. What is the effective annual interest rate that can be locked in today to borrow money in 1 year and repay it in 3 years? Assume this loan is default-free.

3. A bond is said to sell at par when its price is equal to its face value. Suppose that the U.S. government has decided to issue a 3-year coupon bond (with annual coupons) today. What should its coupon rate be for it to sell at par?

4. Suppose that you expect the rate of inflation to be 3% per year for each of the next three years. You are interested in a three-year annuity that would be protected against inflation in the sense that the payment received at the end of every year should give you the same purchasing power as $10,000 today. (a) What nominal payments will this annuity make at the end of the first, second and third years? (b) Using the default-free term structure and the rate of inflation, what is the price today of this annuity?

Show step-by-step how you got to your solutions.

The following nominal default-free bonds are traded in a well functioning capital market today:

Bond Type Face Value Coupon Maturity Price A Zero Coupon Bond $100 - 1 year $95.00 B Coupon Bond $100 6% 2 years $97.92 C Coupon Bond $100 10% 3 years $104.00

1. Assuming that all the bonds make only annual payments, what discount factors (DF1, DF2, DF3) are embedded in these prices? Show all your calculations.

2. What is the effective annual interest rate that can be locked in today to borrow money in 1 year and repay it in 3 years? Assume this loan is default-free.

3. A bond is said to sell at par when its price is equal to its face value. Suppose that the U.S. government has decided to issue a 3-year coupon bond (with annual coupons) today. What should its coupon rate be for it to sell at par?

4. Suppose that you expect the rate of inflation to be 3% per year for each of the next three years. You are interested in a three-year annuity that would be protected against inflation in the sense that the payment received at the end of every year should give you the same purchasing power as $10,000 today. (a) What nominal payments will this annuity make at the end of the first, second and third years? (b) Using the default-free term structure and the rate of inflation, what is the price today of this annuity?

Show step-by-step how you got to your solutions.