Question
Memo 3 On January 1, 2016, Jennifer Baker started to work as an intern in the fixed-income department of the Traveler Mutual Funds. Her supervisor,
Memo 3
On January 1, 2016, Jennifer Baker started to work as an intern in the fixed-income department of
the Traveler Mutual Funds. Her supervisor, Linda Brown, assigned her to analyze interest rate risk
associated with investment in bonds issued by DTE Energy. Ms. Brown provided Jennifer with the
information about four bonds issued by DTE Energy. The four bonds are named as A, B, C, and D.
Bond A
Bond B
Bond C
Bond D
Price on January 1, 2016
123
125
101
103
3
Annual coupon rate
5.8%
5.8%
1.625%
5.4%
Maturity date
12/31/2040
12/31/2036
12/31/2017
12/31/2017
Par value
$1,000
$1,000
$1,000
$1,000
Coupon payment frequency
Semiannual
Semiannual
Semiannual
Semiannual
Rating
A
A
A
A
Then, Ms. Brown assigned Jennifer to do the following research jobs based on the information:
1. Calculate the yield to maturity for the four bonds on January 1, 2016, respectively.
2. Based on the macroeconomic data released by the National Bureau of Economic Research, Ms.
Brown expected that inflation rate will increase by 1%. Hence, she expected that yield to maturity
for the four bonds will increase by 1% too. She asked Jennifer to calculate prices of the four bonds
if the yield to maturity increases by 1%, respectively.
3. List the bond prices of the four bonds on January 1, 2016 and the bond prices of the four bonds
calculated in 2) when the yield to maturity increases by 1% in a table. Jennifer next calculated the
percentage price change of the four bonds.
4. Since Bond A and Bond B have the same coupon rates, Ms. Brown asked Jennifer to compare
which bond price will drop more when the yield to maturity increases by 1%? Since Bond C and
Bond D have the same maturity date, Ms. Brown asked Jennifer to compare which bond price
will drop more when the yield to maturity increases by 1%?
5. Based on the results in 1) through 4), Jennifer needed to report to Linda Brown about which bonds
have higher interest rate risk and why.
Suppose that you are Jennifer Bake and write a short memo addressing 1 through 5 to Ms. Brown. PLEASE SHOW ALL WORK!
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