Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

This problem set question is going through a variety of pricing changes related to a one - period bond with a certain payoff. The equation

This problem set question is going through a variety of pricing changes related to a one-period bond with a certain payoff. The equation for pricing such a bond is:
P=X/ I+ R
Where X is the amount the bond pays and R is the discount rate.
a) At 10am, the discount rate, R, is 10% and the bond pays $100, X, at maturity. What is the price of the bond at 10am?
b) What is the expected return holding the bond to maturity? Do you need to worry about the difference between expected and realized returns? Use the basic return formula, so it will be:
X-P
Return to maturity=p
c) At 11am, the discount rate changes to 25%. What is the price of the bond at 11am? What is the realized return from 10 am until 11am? What is the change in the expected return holding to maturity (R) from 10am until 11am? Are realized and expected returns positively or negatively correlated? Is the news from 10am until 11 am return news or cash flow news?
d) At 12pm we learn that the bond will actually pay $50. The interest rate stays at 25%. What is the price of the bond at 12pm? What is the realized return from 11 am until 12pm? What is the change in the expected return (R) from 11 am until 12pm? Are realized and expected returns positively or negatively correlated? Is the news from 11 am until 12pm return news or cash flow news?
e) What is the return on holding the bond from 10am until 12pm? Did return news or cash flow news have a bigger impact on these returns?
) Use the present value relation to talk about return news and cash flows news for equities. Would you expect to find similar patterns in pricing based on return news and cash flow news for such a stock? Why or why not?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

The Retirees Complete Annuity Handbook

Authors: Scot Whiskeyman

1st Edition

8647470052, 979-8647470058

More Books

Students also viewed these Finance questions