FIN 350 Lecture Notes - Lecture 6: Interest Rate Risk, Put Option, Call Option

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erincamel819

21 Feb 2017

School

Quinnipiac University

Department

Finance

Course

FIN 350

Professor

Porter

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Document Summary

All have a par value of 1,000: the amount of money borrowed. All have a coupon rate: the interest being paid on this loan, usually paid semi annually. All have a maturity: the point in time in which the bond gets paid, you can have a one year, mid-year 3-5, long term 10yr or. The contract of the bond spells out the par value, coupon rate, maturity and any special things: options. Call option- when a person can sell the bond at a certain time with a specific price in the indenture. Put option- the option of the company to force and buy it back from you has a set price in the indenture: sinking funds. The price of a bond can be represented as: cf/ (1+i)^1 + cf/(1+i)^2 . Yield to maturity: the one interest rate the will discount the cash flows back to the price of the bond.

Related Questions

QUESTION 1 The largest investors in corporate bonds are life insurance companies and pension funds. True False 5 points QUESTION 2 Most secondary market transactions for corporate bonds take place through dealers in the over-the-counter (OTC) market. True False 5 points QUESTION 3 The value (or price) of a bond is the present value of its expected future cash flows. True False 5 points QUESTION 4 Bond prices decline when the interest rate decreases. True False 5 points QUESTION 5 The face or par value for bonds is the amount paid to bondholders at maturity and is usually equal to $1,000. True False 5 points QUESTION 6 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond. True False 5 points QUESTION 7 Zero coupon bonds have no coupon payments so they sell for more than their par value. True False 5 points QUESTION 8 Interest rate risk is the risk that bond prices will fluctuate when the interest rate changes. True False 5 points QUESTION 9 US Treasury securities are considered risky investments because the coupon payments are unpredictable. True False 5 points QUESTION 10 Bonds are very difficult to value because their future cash flows are very difficult to predict. True False 5 points QUESTION 11 If the bond's coupon rate is equal to the market rate then the bond will sell at a price equal to its face value greater than its face value less than its face value equal to its foreign currency value, e.g., its price in British pounds 5 points QUESTION 12 When calculating the price of a bond that pays a semiannual coupon one needs to use double the number of years until maturity for the number of payments use half the annual coupon payment use half the annual rate of return as the discount rate all of the above 5 points QUESTION 13 The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments more than the price of the bond equal to zero equal to the price of the bond less than the price of the bond 5 points QUESTION 14 Which one of the following statements is true? All else equal long-term bonds have lower price volatility than short-term bonds. There is an inverse relation between bond prices and market interest rates. All else equal short-term bonds are more risky than long-term bonds. All else equal US government bonds are more risky than corporate bonds. 5 points QUESTION 15 An investor owns a 10-year US government bond with a 9 percent coupon rate. If the yield-to-maturity on the bond is 8 percent then this bond is selling for its par value. a discount. a premium. its face value. 5 points QUESTION 16 BA Corp is issuing a 10-year bond with a coupon rate of 8 percent and a par value of $1,000. The market interest rate on similar bonds is currently 6 percent. If the coupon payments are made annually, what is the value of this bond? 5 points QUESTION 17 Knight, Inc. has issued a 3-year bond with a $1,000 par value and an annual coupon rate of 6 percent. The current market rate of interest is 5 percent. What is the value of this bond if the coupon payments are made semiannually? 5 points QUESTION 18 Diane Carter is interested in buying a 5-year zero coupon bond with a face value of $5,000. If the market interest rate on these types of bonds is currently 9 percent, what is the current price of this bond? 5 points QUESTION 19 Rudy Sandberg wants to invest in 4-year bonds that are currently priced at $933.76. The bonds have a coupon rate of 6 percent and annual coupon payments. If the par value of the bonds is $1,000, what is the bond's yield-to-maturity? 5 points QUESTION 20 You own a 5-year bond with a face value of $1,000 and a coupon rate of 5 percent with annual payments. The bond is currently worth $810.46. If market interest rates remain unchanged, what will be the value of the bond next year when there are 4 years left until maturity?

You plan to buy a car 3 years from now and plan to take out a 3-year car loan. Given the following yield curve and assume that the spot rates are continuous compounded, what will be the interest rate for your car loan?

Yrs to Maturity	1	2	3	4	5	6	7
% yield	4	5	6	7	8	9	10

2. Given the following treasury bonds, calculate the 18-month zero rate. Assume face value of each bond is 100 and coupons are paid semi-annually.

Bond	Yrs to Maturity	Annual coupon rate%	Bond price
A	0.5	0	98
B	1	8	98
C	1.5	9	104

You want to make a 5-year investment on bonds, and if you buy bonds with longer period of maturity, they will be sold at the prevailing market price at the end of the fifth year. All coupons will be reinvested. You forecast that the rates are going to change after you purchase the bonds. Now you have three bonds with same initial YTM to consider: A. 5-year maturity, 6% coupon paid annually, YTM=9% B. 10-year maturity, 8% coupon paid annually, YTM=9% C. 15-year maturity, 4% coupon paid annually, YTM=9% To pick the best one, you want to calculate the following:

1) What are the current prices of three bonds based on the initial YTM given? [2 points]Current prices of all bonds are shown below Bond 1: n=5; PMT = 6; YTM = 9%; FV = 100; PV=calculate = 88.33 It can be calculated by putting the values in the financial calculator OR by using the PV formule in excel which is =PV(9%,5,6,100) Bond 2 n=10; PMT = 8; YTM = 9%; FV = 100; PV=calculate = 93.58 Bond 3 n=15; PMT = 4; YTM = 9%; FV = 100; PV=calculate = 59.7

2) If the coupon payments are reinvested at the prevailing market rate (7% for the coming 5 years), what are the future values (at the end of the fifth year) of all five coupon payments for three bonds respectively? [3 points]

3) What are the selling prices of three bonds at the end of the fifth year, given that the prevailing market rate is 8% at that time? (For bond A, use its par value as the final selling price, as it will mature in 5 years). [2 points]

4) What are the HPRs for the three bonds? [2 points] 5) Whatâs your recommendation? [1 point]

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FIN 350 Lecture Notes - Lecture 6: Interest Rate Risk, Put Option, Call Option

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