FINC 5000

Homework Assignment for Week 3:

Chapter 5:

For Week 3, please turn in the answers to the following questions:

1. Define the following terms as they apply to bonds:

a. Face value

b. Maturity date

c. Coupon interest (including coupon interest rate)

d. Current yield

e. Yield to maturity (YTM)

f. Yield to call (YTC)

g. Call premium

2. What are Zero-coupon bonds?

3. Suppose you see the following bond price quote in the newspaper:

McDonalds 5.7% 2039..122.733

What can you tell about this bond from reading the price quote?

4. (calculating the present value of a bond) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7% and a yield to maturity (YTM) of 4.201%, what should be its price in the bond market (ie, PV)?

5. (calculating the current yield of a bond) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7% and a market price of $1,223.92, what is its current yield?

6. (calculating the YTM of a bond) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7% and a market price of $1,223.92, what is its yield to maturity (YTM)?

7. (calculating the YTC of a bond) Assume a callable corporate bond with a face value of $1,000, a coupon interest rate of 5.7%, a market price of $1,223.92, and a call premium of 6%. Assume also that the bond has 24 years to go until it matures, but it is callable after 14 years. What is the bonds yield to call (YTC)?

8. (calculating the present value of a bond with semi-annual coupon interest payments) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7%, paid semiannually, and has a yield to maturity (YTM) of 4.2%, what should be its price in the bond market (ie, PV)?

9. (calculating the YTM of a bond with semiannual interest payments) If a corporate bond with a face value of $1,000 has 24 years to go until it matures, has a coupon interest rate of 5.7%, paid semiannually, and has a market price of $1,223.92, what is its yield to maturity (YTM)?

10. Define the following terms as they apply to interest rates:

a. The real risk-free rate (r*)

b. The nominal risk-free rate (Rrf)

c. The inflation premium (IP)

d. The default risk premium (DRP)

e. The liquidity premium (LP)

f. The maturity risk premium (MRP)

11. Assume the real risk-free rate is 1%. Assume also that inflation is expected to be 1% in the coming year (year 1), 2% in the next year after that (year 2), and 3% in the year after that (year 3). Assume also that the default risk premium, the liquidity premium, and the maturity risk premium are 0%. Given these conditions, what would be the yield on three-year treasury bonds today?

12. Suppose the First Bank of St Louis was offering the following rates on certificates of deposit (CDs) this week:

MaturityRate

3 month1.50%

6 month1.75%

1 year2.00%

2 year2.25%

3 year2.50%

5 year2.75%

10 year3.00%

20 year3.15%

a. Plot the above data on a yield curve. Label the graph and the axes appropriately.

b. Comment on the implications of this curve to you, as a potential investor in CDs.

End of assignment questions

(see answers to numerical problems on the next page)

Answers to numerical problems:

Question 4: $1,223.92

Question 5: 4.66%

Question 6: 4.2%

Question 7: 3.92%

Question 8: $1,225.44

Question 9: 4.21%

Question 11: 3.0%