3. Between a callable bond (Security C) and a mortgage-backed security (Security M), both with 6.25% rates and 4-year terms, and considering falling market interest rates, which should a risk minimizer investor pick for a 6-month horizon? Why?

4. If the market rate changes by 125 basis points from the current 7.875%, which of Bond F (0% coupon), Bond Z (6% coupon), and Bond 0 (coupon of T-bill rate + 1.5%) would face the most and least impact on their value? Explain why.

1. Suppose you purchased a bond with a 5% annual coupon payment that expires in 10. Two years later the risk-free rate is 7%. Have you been exposed to interest rate risk? Have you been exposed reinvestment risk? Briefly explain why and what interest and reinvestment risk are.

2. Assuming all other bond characteristics are identical which bond would pay a higher coupon payment? Very briefly explain why.

a. A callable bond or a convertible bond

b. A bond with negative covenants vs a bond without negative covenants

c. A Treasury Strip or a regular Treasury bond

d. A secured vs unsecured bond

3. A coupon bond pays interest semi-annually, matures in 30 years, has coupon rate of 4% and is currently selling for $700. What is the annual YTM? Show your work.

4. A semi-annual step-up bond matures in 11 years and pays zero coupon payments for the first 5 years. During the remaining life of the bond it pays a 5% coupon payment. If the bond has a YTM of 8% what is the current price of the bond? Show your work.

5. Why are money markets needed in addition to banks? What cost advantages do the money markets provide?

6. Briefly describe the main differences between the following money market securities:

a. Repurchase agreements and federal funds

b. Commercial paper and treasury bills

How can you consider the TBA market of mortgage backed securities a kind of a forward market? Explain in your own words.

An investor is considering one of the newly issued 10 year AAA corporate bonds shown in the following table:

A. Suppose that market interest rates decline by 100 basis points (1%). Contrast the effect of this decline on the price of each bond.

B. Should the investor prefer the RST bond to the XYZ bond when rates are expected to rise or to fall?

C. What would be the effect, if any, of an increase in the volatility of interest rates on the prices of each bond?