Sam Strother and Shawna Tibbs are vice presidents of Mutual ofSeattle Insurance
Company and co-directors of the companyâs pension fund managementdivision. An
important new client, the North-Western Municipal Alliance, hasrequested that Mutual
of Seattle present an investment seminar to the mayors of therepresented cities, and
Strother and Tibbs, who will make the actual presentation, haveasked you to help them
by answering the following questions.
a. What are the key features of a bond?
b. What are call provisions and sinking fund provisions? Do theseprovisions make
bonds more or less risky?
c. How does one determine the value of any asset whose value isbased on expected
future cash flows?
d. How is the value of a bond determined? What is the value of a10-year, $1,000 par
value bond with a 10% annual coupon if its required rate of returnis 10%?
e. (1) What would be the value of the bond described in Part d if,just after it had been
issued, the expected inflation rate rose by 3 percentage points,causing investors
to require a 13% return? Would we now have a discount or a premiumbond?
(2) What would happen to the bondâs value if inflation fell and rddeclined to 7%?
Would we now have a premium or a discount bond?
(3) What would happen to the value of the 10-year bond over time ifthe required
rate of return remained at 13%? If it remained at 7%? (Hint: With afinancial
calculator, enter PMT, I/YR, FV, and N, and then change N to seewhat happens
to the PV as the bond approaches maturity.)
f. (1) What is the yield to maturity on a 10-year, 9% annualcoupon, $1,000 par value
bond that sells for $887.00? That sells for $1,134.20? What doesthe fact that a
bond sells at a discount or at a premium tell you about therelationship between
rd and the bondâs coupon rate?
(2) What are the total return, the current yield, and the capitalgains yield for the
discount bond? (Assume the bond is held to maturity and the companydoes not
default on the bond.)
Sam Strother and Shawna Tibbs are vice presidents of Mutual ofSeattle Insurance
Company and co-directors of the companyâs pension fund managementdivision. An
important new client, the North-Western Municipal Alliance, hasrequested that Mutual
of Seattle present an investment seminar to the mayors of therepresented cities, and
Strother and Tibbs, who will make the actual presentation, haveasked you to help them
by answering the following questions.
a. What are the key features of a bond?
b. What are call provisions and sinking fund provisions? Do theseprovisions make
bonds more or less risky?
c. How does one determine the value of any asset whose value isbased on expected
future cash flows?
d. How is the value of a bond determined? What is the value of a10-year, $1,000 par
value bond with a 10% annual coupon if its required rate of returnis 10%?
e. (1) What would be the value of the bond described in Part d if,just after it had been
issued, the expected inflation rate rose by 3 percentage points,causing investors
to require a 13% return? Would we now have a discount or a premiumbond?
(2) What would happen to the bondâs value if inflation fell and rddeclined to 7%?
Would we now have a premium or a discount bond?
(3) What would happen to the value of the 10-year bond over time ifthe required
rate of return remained at 13%? If it remained at 7%? (Hint: With afinancial
calculator, enter PMT, I/YR, FV, and N, and then change N to seewhat happens
to the PV as the bond approaches maturity.)
f. (1) What is the yield to maturity on a 10-year, 9% annualcoupon, $1,000 par value
bond that sells for $887.00? That sells for $1,134.20? What doesthe fact that a
bond sells at a discount or at a premium tell you about therelationship between
rd and the bondâs coupon rate?
(2) What are the total return, the current yield, and the capitalgains yield for the
discount bond? (Assume the bond is held to maturity and the companydoes not
default on the bond.)
