Money and Banking

1. Suppose semi-annual coupon bond with five-year maturity, coupon rate of 4%,

and face value of $1000 cost $990 to purchase one year ago.

A: Was the yield to maturity on the bond greater than, less than or equal to 4%.

Explain in one sentence how you know this.

B: Suppose after a year, the current market price is $970. Did yield to maturity

increase, decrease or remain the same? Explain in one sentence how you know this.

C: What was the return on the bond?

D: Suppose investors expect two possible outcomes for prices of the security in the

over the course of the next year. With probability 0.65, investors expect the price to be $980.

With probability 0.35, investors expect the price to be $965. Calculate the expected value and

standard deviation of the future price.

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2: Suppose Polar Telecom issues a semi-annual coupon bond with a 12 year

maturity, face value of $1000 and coupon rate of 6%.

A: Suppose the yield to maturity on the bond is 8%. Write down how you would price this bond using the present value formula. Make sure to include the relevant values for payment, i and N in the formula

B: Price the bond assuming yield to maturity of 8%.

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3: Suppose a discount bond with face value of $1000 and maturity of four years

currently trades for price $860.

A: What is the yield to maturity on this bond?

B: Suppose the inflation rate over the next four years is expect to average 2% per year. What is expected purchasing power of the face value of the security in current dollars?

C: What is the real interest rate?

D: Suppose instead of 2%, the actual inflation rate is 4%. What is the realized real interest rate?

E: if the inflation rate is higher than expected, who is made worse off and who is

better off?