FIL 241 Exam 2

Advantages of TIPS:

-Protected from inflation -The yield on a TIPS is a real rate of return since the principal is adjusted for inflation.

Disadvantages of TIPS:

-principal adjustments are subject to tax each year -coupon rate is low

The United States Treasury announces an auction for 5-year T-notes in the amount of $12bln. No non-competitive bids were received. The following are the top competitive bids received: Bidder #1: $3bln. at 1.25% Bidder #2: $2bln. at 1.26% Bidder #3: $4bln. at 1.275% Bidder #4: $2.5bln. at 1.275% Bidder #5: $1.5bln. at 1.28% Bidder #6: $2bln. at 1.28% Bidder #7: $0.8bln at 1.285% What will be the coupon rate on the note?

1.25% Feedback: The stop-out (highest accepted) yield is 1.28%. The coupon rate for an issue is the stop-out rate rounded down to the nearest one-eighth of 1%, or 0.125%. Thus, the coupon rate on the note will be 1.25%, and it will be priced to have the yield to maturity of 1.28%.

The yield on a 5 year Treasury note is 4.5% and the yield on a 5 year TIPS is 2.4%. What is the market's estimate of the annual inflation rate over the next 5 years?

2.1% (i.e. expected annual inflation=non-TIPS yield-TIPS yield)

The U.S. Treasury announces an auction for 5-year T-notes in the amount of $15bln. Non-competitive bids received total $2bln. The following are the top competitive bids received: Bidder #1: $3bln. at 3.15% Bidder #2: $2bln. at 3.16% Bidder #3: $4bln. at 3.175% Bidder #4: $2.5bln. at 3.18% Bidder #5: $1.5bln. at 3.195% Bidder #6: $1.9bln. at 3.20% Bidder #7: $0.8bln at 3.205% What is the auction's stop-out yield?

3.195% Feedback: Noncompetitive bids are satisfied first. The stop-out (highest accepted) yield is 3.195%. The coupon rate for an issue is the stop-out rate rounded down to the nearest one-eighth of 1%, or 0.125%. Thus, the coupon rate on the note will be 3.125%, and it will be priced to have the yield to maturity of 3.195%.

What is the YTM of a 4% annual coupon rate bond with 8 years to maturity, par value of $1,000, and semiannual payments if it sells for $982?

4.27%

You just bought a 5-year, $1000 par, 8% semiannual coupon bond for $1070. You expect to sell it after 3 years (6 interest payments) for $975. What is your expected yield?

4.69%

You bought a 7 year, $1000 par, 8% annual coupon rate bond with semiannual coupon payments for $1070. You sold it after 3 years (6 int. payments) for $1020. What is your realized yield?

6.03%

A $1,000 par bond with a coupon rate of 7% and coupons paid annually matures in 8 years. If the bond is now selling for $950, what is its yield to maturity?

7.9%

The % change in bond price for a given change in interest rates is________.

Bond Price Volatility

How is bond volatility related to coupon rate?

Bond volatility is directly related to term-to-maturity and inversely related to coupon rate.

The actual realtionship between bond prices and yields is ________; if the yield rises by 1%, the bond price will fall by _______ it will rise if the yield falls by 1%

Convex; less than

A measure of interest rate risk (or price bond volatility) that considers both coupon rate and maturity.

Duration

The risk related to changes in interest rates that cause a bonds total return to differ from the promised yield-to-maturity is________.

Interest Rate Risk

Changes in interest rate cause the market a bond to rise or fall, resulting in capital gains or losses to the investor is _________.

Price Risk

The return earned on a bond give the cashflows actually received by the investor and assuming that the coupon payments are reinvested at the realized yield is_________.

Realized Yield

If a bond investor receives all the coupon payments on time and the face value on the contract maturity date, investor's return could still vary because of _________ risk.

Reinvestment

The change is a bonds total return caused by changing coupon reinvestment rates is ________.

Reinvestment Risk

A Treasury security separated in its component parts such that each interest payment and the principal payment become separate zero coupon securities.

STRIPS

Markets for liquidity Lenders'. Their primary concern is the abilityto retrieve all of their cash when needed.

TIPS

The yield to maturity measure assumes that a bonds coupons are reinvested at ________.

The yield to maturity

If an investor wanted to purchase bonds with no or extremely low credit risk and to eliminate reinvestment risk, he should purchase _______.

Treasury STRIPS

Bond Characteristics:

a.Bonds with higher coupon rates have shorter durations than bonds with smaller coupons of the same maturity. b.There is generally a positive relationship between term-to-maturity and duration c.For bonds with a single payment, duration is equal to term-to-maturity. d.All other factors held constant, the higher the market rate of interest, the shorter the duration of the bond.

Which of the following is true about duration?

a.Duration can be used to measure a bonds interest rate risk b.All else equal, higher coupon rates mean lower duration c.Duration is equal to maturity for zero-coupon bonds. d.All else equal, longer maturities mean higher duration e.all the above e

Which of the following statements is true?

a.Low-coupon bonds are to more sensitive to interest rate changes compared high-coupon bonds, holding everything else constant. b.Bond prices are inversely related to bond yields. c.Long-term bonds are more sensitive to interest rate changes than short-term bonds, all else equal. d.all the above d

Why do fixed-rate bond prices change with interest rates?

because of the fixed nature of the bonds coupon rate.

The actual bond price change for a 1% yield increase is a decrease of 5%. If you use duration to estimate the bonds price change for the same yield change, it would predict a(n)_________ of ________.

decrease; more than 5%

Bond A has a duration of 7 years, bond B has a duration of 8 years. Bond B will have __________.

greater change in price for a given change in interest rates, relative to bond A.

You use duration to estimate a bond's price sensitivity to yields, and it predicts the price would increase by 5% if the yield decreased by 1%. The actual bond price change for a 1% yield decrease will be a(n) _____ of _____.

increase; more than 5%

If a bond's yield to maturity is greater than the coupon rate, the bond must be _________.

selling at a discount

In TIPS, ________ adjusts with inflation.

the principal