5. Your friend Earn recently dropped out of Princeton, moved back home, and got a job trying to get people to sign up for airline rewards credit cards at the airport. He stops by your apartment to hang out, and he sees the Wall Street Journal laying on the coffee table. Hes super impressed that you get an actual newspaper delivered and decides to ask you for financial advice. Hes a little nervous about his job prospects with uncertainty around the elections and proposed tariffs, so hed like to increase his savings and invest some of it. You dont ordinarily advise people without collecting your usual fee, but Earn has come through for you in the past, and so you offer to give him some basics on bonds and show him how to read the yield curve.

a) You tell Earn that the best choice for him is a corporate bond with par value of $1000, annual coupons of 4.0% and four years to maturity. From the yield curve, you determine the following spot rates are appropriate for cash flows of this level of risk.

Time (Years)	1	2	3	4
Rate (%)	2.00	3.00	3.25	3.50

How much should Earn pay for the bond?

This seems like a reasonable price to Earn, but he wants to know what kind of return he can expect. You tell him that depends on how long he holds the bond.

b) What is the yield to maturity?

c) You explain to Earn that the yield to maturity is the rate of return that he can expect if he buys the bond today, holds it until maturity, and reinvests the coupons at that yield to maturity. Earn thinks those assumptions are pretty strong. He heard from some people in New Jersey that interest rates matter a lot. Hes pretty clever and is worried that other characteristics might affect how interest rates matter. You agree to try and help him understand if hes right. You show him some other bonds that are available for purchase.

Corporate Debt

Investment-grade

Issuer	Symbol	Annual Coupon	Maturity	Fitch Rating	YTM	Callable
General Electric	GE	0.000%	Sep 19 2020	A	2.000%	No
Colgate-Palmolive	CL	0.000%	Sep 19 2026	A	2.000%	No
Morgan Stanley	MS	6.000%	Sep 19 2020	A	2.000%	No

Find the price of bonds GE, CL, and MS. Assume these bonds pay annual coupons.

d) Earns phone buzzes. He checks it thinking it might be Van letting him know he can crash at her place tonight, but actually its a news alert that interest rates just went up. Now the YTM of all three bonds is 6.000%. Find the price of each bond now.

e) For each bond, state the dollar change in price when yields increased.

f) For each bond, state the percentage change in price (relative to the initial price in part c) when yields increased.

g) Looking at the percentage change for bonds GE and CL, what can you conclude (in 10 words or less!!!) about time to maturity and how sensitive the change in bond price is to changes in interest rates?

Ill get you started:

Bond prices are more sensitive to changes in interest rates when

h) Looking at the percentage change for bond GE and MS, what can you conclude (in 10 words or less!!!) about coupon rate and how sensitive the change in bond price is to changes in interest rates?

Bond prices are more sensitive to changes in interest rates when