Download Finance 301 Chapter 6: Problems 10/16/08 30 day T

Finance 301
Chapter 6: Problems
10/16/08
1.
30 day T-Bills are currently yielding 5.8%. You know the following are the
current interest rate premiums. Calculate the real risk free rate of return.
a. Inflation premium=4%
b. Liquidity premium= 1.8%
c. Maturity Risk premium= 0.75%
d. Default Risk premium= 2.35%
r=r* + IP + LP + MRP + DRP
rTbill= r* + IP
5.8= r* + 4
-4
-4
1.8%= r*
2. The real risk free rate is 4%. Inflation is expected to be 3% this year, 4% next
year, and then 2% for the following 2 years. Assume that the maturity risk
premium is 0. What is the yield on 2 year Treasury securities? What about 4
year treasury securities?
2 year:
4 year
rTbill= r* + IP
rTbill= r* + IP
r= 4 + [(3 + 4)/2]
r=4 + [(3+4+2+2)/4]
r= 4 + 3.5
r= 4 + 2.75
r= 7.5%
r=6.75%
3. The real risk free rate is 3%, and inflation is expected to be 3.5% for the next 2
years. A 2 year treasury security yields 6.8%. What is the maturity risk premium
for the 2 year security?
rTBill-2 year= r* + IP + MRP
6.8%= 3 + 3.5 + MRP
-6.5 -6.5
0.3% = MRP
4. One year treasury securities yield 5.5%. The market anticipates that one year
from now, 1 year treasury securities will yield 6.5%. If the pure expectations
theory holds, what is the yield today for 2 year treasury securities?
(1 + x)2= (1.055)1(1.065)1
(1+x)2= 1.1236
√
√
1+x= 1.06
-1 -1
x= 0.06
or 6%
5. Interest rates on 4 year treasury securities are currently 8%, while 6 year treasury
securities are 8.5%. If pure expectations theory is correct, what doe sthe market
believe that 2 year securities will be yielding 4 years from now? (round everything
to 4 decimal places)
(1.08)4 (1 + x)2= (1.085)6
1.3605 (1 + x)2= 1.6315
÷1.3605
÷1.3605
(1 + x)2= 1.1992
√
√
1 + x= 1.0951
-1
-1
x= 0.0951
or 9.51%
Chapter 7 Stuff
6. What is a bond?
a. Money paid to an investor to compensate him/her for taking on risk
b. A premium paid to counteract the effects of inflation
c. A long term debt interest under which the borrower agrees to make
payments of interest and principal on specific dates, to the holders of the
bond.
d. Something that is used to tie someone down.
7. What are the four main types of bonds?
1 treasury bonds- issued by federal gov’t. aka gov’t bonds
2 corporate bonds- issued by corporations
3 municipal bonds- issued by state and local governments
4 foreign bonds- issued by foreign gov’ts or foreign corporations
8. Why aren’t U.S. Treasury Bonds completely riskless?
U.S. Treasury bonds are not completely riskless because their prices decline when
interest rates rise.
9. What is the other type of risk (not default risk) that U.S. investors face when
investing in foreign bonds?
Additional risk exists if the bonds are denominated in a currency other than the
dollar. If the value of that currency falls relative to the value of the dollar (home
currency)
10. What is par value of a bond?
a. How much the interest is worth
b. The face value of the bond.
c. The state annual interest rate on the bond
d. The number of years to maturity at the time the bond is issued
11. What is the coupon payment?
a. The face value of the bond.
b. The amount of interest paid each year (in dollars)
c. The stated annual interest rate on a bond.
d. I don’t have a clue.
12. A bond’s ________date is a specified date on which the ___
bond must be repaid.
a. Coupon, par value
b. Maturity, coupon payment
c. Maturity, par value
d. Provision, par value
_____ of the
13. Describe the concept of a call provision
A call provision is a provision in a bond contract that gives the issuer the right to
redeem the bonds unders specified terms prior to the maturity date.
Usually, if the bonds is called early, the issuer has to pay a call premium that awards
the bond holder with more money than par. (example a 10% premium on a 100
dollar bond would give the holder 110 dollars if it were called early.)
There is also something called “call protection” that prohibits the bonds from being
called for a certain period of time (generally 5-10 years) after issue.
14. What is a zero coupon bond?
A bond that does not pay interest, but is sold at a discount below par so as to
compensate the buyer in terms of capital appreciation.
15. What is a floating rate bond?
a. A bond that does not have a maturity date
b. A bond that is sold at a discount below par
c. A bond with a $1000 face value
d. A bond whose interest rate fluctuates with shifts in the general level of
interest rates.