Reference no: EM132678282

Questions -

Q1. Consider a 5-year $1000 face value bond which has a 10% coupon rate. Currently, it is thought that interest rates will remain constant at 3% for the full five periods. Suddenly, there is 'news' that interest rates will almost certainly rise to 5% for the last two periods. What would happen to the bond's price, given this news?

Q2. Consider a 10-year $1000 face value bond with a 5% coupon rate. The investor buys the bond for $1100 but a liquidity shock forces him to sell it after two periods for exactly the face value. Coupons are not reinvested. What is the average annualized yield?

Q3. In the above, what difference in annualized yield would there be if the first coupon was in fact reinvested at 5%?

Q4. Likewise, what difference would there be in annualized yield if the coupons were not reinvested but the investor sold instead after three periods for $1050?

Q5. Suppose the investor managed to hold this bond to maturity. What would the yield to maturity be?

Q6. Consider a 10-year $1000 face value bond with a 10% coupon rate. The investor buys the bond for $900 and sells it for $1100 after four years. Coupons are not reinvested. What is the average annualized return?

Q7. Suppose in the above that the coupons were reinvested at 10%. What would his effective annualized yield be now?

Q8. Consider a 5-year, 10%, $1000 face value bond, bought for $900 at time t, which has a price of $1000 at t+1, $1100 at t+2, $1150 at t+3, $1050 at t+4, and $1000 at maturity. If the investor wanted to maximize his annualized return, when should they sell this bond?

Q9. At the 5-year maturity date, what would you expect this annualized return to converge to?

Q10. A fussy investor always wants at least 15% from every investment made. A 2- year, $1000 face value discount (zero-coupon) bond is selling for $800. Would they buy it?

Q11. An investor buys a $1000 face value, 10-year bond with a 10% coupon rate at par value. A week after buying it, the corporation announces severe liquidity problems and states that there is only a 50/50 chance that the coupons and final payment will be paid. What would be the yield on this bond, given the announcement?

Q12. Explain how this announcement could make this bond receive a risk premium.

Q13. Suppose that an investor received 'news' that interest rates would move increasingly downward for a number of years. Would that bias the investor to holding more long-term bonds in his portfolio? Explain.

Q14. Suppose that current global uncertainty and high household debt levels now make the probability of liquidity shocks much greater than before. Would that actually make long-term bonds relatively less risky as compared with shortterm bonds?

Q15. Consider the same $1000, 5-year, 10% coupon bond as above, bought at par. Just after you have bought it, it recognized that there will be 5% inflation per period, thus depreciating the real value of future coupons by 5% in each subsequent period. How will this affect its yield to maturity, i? What will happen if people start selling this bond?