ECON 132A Lecture Notes - Lecture 12: United States Treasury Security, Municipal Bond, Investment

47 views2 pages

periwinklesnail857

31 May 2016

School

Department

Course

Professor

For unlimited access to Class Notes, a Class+ subscription is required.

Document Summary

Have lower risk, a fixed rate of return, long term security. Inflation risk: if a bond pays 1. 5% and inflation rises to 3%, you lose money. Interest rate risk: today you can buy a government bond paying 1. 75% at. If rates go up between now and 10 years, you won"t be able to sell that bond for ,000. This makes your bond less attractive, so you would have to sell it for less. The value of a bond can go up or down for a variety of reasons, one of them being interest rates. We are at a historical low for interest rates (so if you invest in bonds now, you believe that rates might still decrease) Security that obligates issuer to make payments to holder over time. Face value, par value: payment to bondholder at maturity of bond. Coupon rate (contract rate): bond"s annual interest payment per dollar of par value.

Related Questions

Question 1.

a. What is the difference between interest rates and returns on a bond? Is the RET equal to the interest rate? Why or Why not?

b. What would be the rate of return on a coupon bond bought at face value of $1000 today( with a coupon rate of 15%) and sold for $1200 one year later ?

c. What is the method to calculate the rate of Capital Gain (g)? Is there a capital gain or loss in the above cae? How much?

Question 2.

Explain why you would be more or less willing to buy long-term Government bonds under the following scenarios: Use a demand and supply analysis for bonds, with a given initial equilibrium in the bonds market. ( Diagram necessary)

a.Trading in these bonds increases, making them easier to sell.

b.Relative risk of these bonds compared to other types falls

c.Suppose government has a surplus

Question 3.( Diagram nesscesary)

a. What is the distinction between Real and Nominal Interest rates?

b. Suppose we have an equilibrium in the bonds market with a given expected inflation (he). If inflation rate increases, What will happen to the demand and supply of bonds? Would you be able to say for sure (i.e. with certainty) what will happen to the price of bonds and what will be the quantity bought and sold? Why or why not?

6. If there is a shortage of loanable funds, then

a.	the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and the interest rate is above equilibrium.
b.	the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and the interest rate is below equilibrium.
c.	the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and the interest rate is above equilibrium.
d.	the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and the interest rate is below equilibrium.

7. We associate the term debt finance with

a.	the bond market and we associate the term equity finance with the stock market.
b.	the stock market and we associate the term equity finance with the bond market.
c.	financial intermediaries and we associate the term equity finance with financial markets.
d.	financial markets and we associate the term equity finance with financial intermediaries.

8. If the demand for loanable funds shifts to the right, then the equilibrium interest rate

a.	and the quantity of loanable funds rises.
b.	and the quantity of loanable funds falls.
c.	rises and the quantity of loanable funds falls.
d.	falls and the quantity of loanable funds rises.

9. Long-term bonds are

a.	riskier than short-term bonds, and so interest rates on long-term bonds are usually lower than interest rates on short-term bonds.
b.	riskier than short-term bonds, and so interest rates on long-term bonds are usually higher than interest rates on short-term bonds.
c.	less risky than short-term bonds, and so interest rates on long-term bonds are usually lower than interest rates on short-term bonds.
d.	less risky than short-term bonds, and so interest rates on long-term bonds are usually higher than interest rates on short-term bonds.

10. Compared to bondholders, stockholders

a.	face higher risk and have the potential for higher returns.
b.	face higher risk but receive a fixed payment.
c.	face lower risk and have the potential for higher returns.
d.	face lower risk but receive a fixed payment.

11. The old adage, 'don't put all your eggs in one basket', is very similar to a modern bit of advice concerning financial matters:

a.	Buy low-risk bonds.
b.	Use a medium of exchange.
c.	Diversify.
d.	Intermediate.

12. A budget surplus is created if

a.	the government sells more bonds than it buys back.
b.	the government spends more than it receives in tax revenue.
c.	private saving is greater than zero.
d.	None of the above is correct.

greenwildebeest673

This assignment requires the following knowledge: For k different events, if the probability that each of them happens is p (0 < p < 1) and all events happen independently, the probability that all events happen together is p^k.
1. Five firms, namely A, B, C, D and E, issue discounted bonds with face value $1,000 and maturity 5 years in the market. All firms are pretty risky and each of them has a chance of 0.5 of collapse during the five years (thus bankrupted and can not pay back the bond accordingly). The bonds are all sold at an interest rate of 50% (the value is not surprising due to the extremely high risk of default).
(1) What is the present value of the bond given the interest rate, the face value and the maturity? Hint: we temporarily do not consider the issue of default.
(2) Say now you buy one bond from each of the five firms, what is the total amount you lend out today? Eventually only one firm does not fail and pays back the bond, what is the money you collect back 5 years later? You gain or loss in this case? If more than one firm pays back the bond, will you get more money back?
(3) What is the chance (probability) that you get nothing back assuming that firms fail independently? Together with the answer in (2), is it a good deal to buy one bond from each of the five firms?
(4) Repeat (2) and (3) with the only difference that now you buy 5 bonds from a single firm.
(5) Now we assume that the five firms all have similar businesses in Greece (and those are their only businesses), therefore, all firm fail together if the economy in Greece fails. Will you answer in (3) change?

ECON 132A Lecture Notes - Lecture 12: United States Treasury Security, Municipal Bond, Investment

Document Summary

Get access

Related Documents

FI 455 Study Guide - Final Guide: Interest Rate, Opportunity Cost

FI 455 Lecture Notes - Lecture 39: Premium Bond, Zero-Coupon Bond

FINA 2201 Chapter Notes - Chapter 7: Bankruptcy Act, Current Yield, Sinking Fund

Related Questions