A 2-year $1,000 par zero-coupon bond is currently priced at $819.00. A 2-year $1,000 annuity is currently priced at $1,712.52. If you want to invest $10,000 in one of the two securities, which is a better buy? You can assume

the pure expectations theory of interest rates holds,

neither bond has any default risk, maturity premium, or liquidity premium, and

you can purchase partial bonds.

Consider the two bonds described below:

	Bond A	Bond B
Maturity	15 yrs	20 yrs
Coupon Rate (Paid semiannually)	10%	6%
Par Value	$1,000	$1,000

If both bonds had a required return of 8%, what would the bonds prices be?

Describe what it means if a bond sells at a discount, a premium, and at its face amount (par value). Are these two bonds selling at a discount, premium, or par?

If the required return on the two bonds rose to 10%, what would the bonds prices be?

M&E Inc. has an outstanding convertible bond. The bond can be converted into 20 shares of common equity (currently trading at $52/share). The bond has 5 years of remaining maturity, a $1,000 par value, and a 6% annual coupon. M&Es straight debt is currently trading to yield 5%.

What is the minimum price of the bond?

Assume the debt in part a) is trading at 1,035. If you were in possession of one of these bonds would you convert or sell the bond? Which option is more profitable and by how much?

A 7-year, $1,000 par bond has an 8% annual coupon and is currently yielding 7.5%. The bond can be called in 2 years at a call price of $1,010. What is the bond yielding, assuming it will be called (What is the yield to call)?

A 20-year $1,000 par value bond has a 7% annual coupon. The bond is callable after the 10th year for a call premium of $1,025. If the bond is trading with a yield to call of 6.25%, what is the bonds yield to maturity?

An insurance company is analyzing three bonds and is using duration as the measure of interest rate risk. All three bonds trade at a yield to maturity of 10 percent, have $10,000 par values, and have five years to maturity. The bonds differ only in the amount of annual coupon interest they pay: 8, 10, and 12 percent.

What is the duration for each five-year bond? (Excel use is recommended)

What is the relationship between duration and the amount of coupon interest that is paid?

You can obtain a loan of $100,000 at a rate of 10 percent for two years. You have a choice of (i) paying the interest (10 percent) each year and the total principal at the end of the second year or (ii) amortizing the loan, that is, paying interest (10 percent) and principal in equal payments each year. The loan is priced at par.

What is the duration of the loan under both methods of payment?

Explain the difference in the two results.

Calculate the duration of a two-year, $1,000 bond that pays an annual coupon of 10 percent and trades at a yield of 14 percent. What is the expected change in the price of the bond if interest rates fall by 0.50 percent (50 basis points)?

You have discovered that the price of a bond rose from $975 to $995 when the yield to maturity fell from 9.75 percent to 9.25 percent. What is the duration of the bond?