Unit 2 - CH 3 Final Exam Practice - Financial Markets
The one-year spot interest rate is R1 = 5% and the two year rate is R2 = 6%. If the expectations theory is correct, what is the expected one year interest rate in one years time?
7.01% (the extra return that you earn for investing for two years rather than one is 1.06^2/1.05-1 = .0701)
A 10 - year German government bond (bund) has a face value of 100 (euros) and a coupon rate of 5% paid annually. Assume that the interest rate (in euros) is equal to 6% per year. What is the bonds PV?
92.64 Euros
A 10 year us treasury bond with a face value of $10,000 pays a coupon of 5.5% (a six-month discount rate of 5.2/2 =2.6%). Generate a graph or table showing how the bonds present value changes for semiannually compounded interest rates between 1% and 15%.
BUILD OUT IN EXCEL
Which comes first in the market for US Treasury bonds: Bond prices or YTM?
Bond prices. The bond price is determined by the bonds cash flows and the spot rates of interest. Once you know the bond price and the bonds cash flows, it is possible to calculate the YTM.
A 10-year bond is issued with a face value of $1,000, paying interest of $60 a year. If market yields increase shortly after the T-bond is issued, what happens to the bonds COUPON RATE?
Does not change
T/F If interest rates rise, bond durations rise also.
False. A higher interest rate reduces the relative present value of (distant) principal repayments.
T/F Longer maturity bonds necessarily have longer durations
False. Duration depends on the coupon as well as the maturity.
T/F The longer a bonds duration, the lower is volatility.
False. Given the YTM, volatility is proportional to duration.
EXPLAIN WHY: If a bonds coupon rate is higher than its yield to maturity, then the bond will sell for more than face value.
If a bonds coupon rate is higher than its YTM, then its coupon payment exceeds the coupon payment for a face value bond with the same maturity (i.e. a bond whose coupon rate is equal to its YTM). So investors will pay a premium for the bond (where the premium is the present value of the difference in coupon payments)
EXPLAIN WHY: If a bonds coupon rate is lower than its yield to maturity, then the bonds price will increase over its remaining maturity.
If a bonds coupon rate is lower than its YTM, then its coupon payment is below the coupon payment for a face value bond with the same maturity (i.e. a bond whose coupon rate is equal to its YTM). So investors will demand a discount on the bond (where the discount is the present value of the difference in the coupon payments).
A 10-year bond is issued with a face value of $1,000, paying interest of $60 a year. If market yields increase shortly after the T-bond is issued, what happens to the bonds PRICE?
Price falls
The two year interest rate is 10% and the expected annual inflation rate is 5%. What is the expected real interest rate?
Real rate = 1.10/1.05-1 = .0476 or 4.76%
Which comes first in the market for US Treasury bonds: Spot rates or YTM?
Spot interest rates. YTM is a complicated average of the separate spot rates of interest
The two year interest rate is 10% and the expected annual inflation rate is 5%. If the expected rate of inflation suddenly rises to 7%, what does fishers theory say about how the real interest rate will change? What about the nominal rate?
The real rate does not change. The nominal rate increases to 1.0475 x 1.07 - 1 = .120952 or 12.10%
In February 2009 Treasury 6s of 2026 offered a semiannually compounded yield of 3.5965%. Recognizing that coupons are paid semiannually, calculate the bonds price.
The yield over 6 months is 3.5965/2 = 1.79825% Therefore, PV = 130.37
T/F Other things equal, the lower the bond coupon, the higher its volatility
True. A lower coupon rate means longer duration and therefore higher volatility.
A 10-year bond is issued with a face value of $1,000, paying interest of $60 a year. If market yields increase shortly after the T-bond is issued, what happens to the bonds YIELD TO MATURITY?
Yield rises
A 10 year us treasury bond with a face value of $10,000 pays a coupon of 5.5% (a six-month discount rate of 5.2/2 =2.6%) What is the present value of the bond?
$10,2321.64