Chapter 3: 10-15I (page 329)
Treasury bonds paying an 8% coupon rate with semi-annual payments currently sell at par value. What coupon rate would they have to pay in order to sell at par if they paid their coupons annually?
Treasury bonds will have to pay a coupon rate of 8.16%
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Question: A newly issued bond pays its coupons once a year. Its coupon rate is 5%, its maturity is 20 years, and its yield to maturity is 8%.
a. Find the holding-period return for a one-year investment period if the bond is selling at a yield to maturity of 7% by the end of the year.
b. If you sell the bond after one year when its yield is 7%, what taxes will you owe if the tax rate on interest income is 40% and the tax rate on capital gains income is 30%? The bond is subject to original-issue discount (OID) tax treatment.
c. What is the after-tax holding-period return on the bond?
d. Find the realized compound yield before taxes for a two-year holding period, assuming that (i) you sell the bond after two years, (ii) the bond yield is 7% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 3% interest rate.
e. Use the tax rates in part ( b ) to compute the after-tax two-year realized compound yield. Remember to take account of OID tax rules.
A convertible bond has the following features:
Coupon | 5.25% |
Maturity | June 15, 2020 |
Market price of bond | \(77.50 |
Market price of underlying common stock | \)28.00 |
Annual Dividend | $1.20 |
Conversion ratio | 20.83 shares |
Calculate the conversion premium for this bond.
A member of a firm’s investment committee is very interested in learning about the management of fixed-income portfolios. He would like to know how fixed-income managers position portfolios to capitalize on their expectations concerning three factors influencing interest rates. Assuming that no investment policy limitations apply, formulate and describe a fixed-income portfolio management strategy for each of the following interest rate factors that could be used to exploit a portfolio manager’s expectations about that factor.
( Note: Three strategies are required, one for each listed factor.)
a. Changes in the level of interest rates.
b. Changes in yield spreads across/between sectors.
c. Changes in yield spreads as to a particular instrument.
Return to Table 10.1 and calculate both the real and nominal rates of return on the TIPS bond in the second and third years.
Time | Inflation in Year just ended | Par Value | Coupon Payment | Coupon Payment + Principal payment | Total Payment |
0 | \( 1000 .00 | ||||
1 | 2 | \) 1020.00 | \( 40.80 | 0 | \) 40.80 |
2 | 3 | \( 1050. 60 | \) 42.02 | 0 | \( 42.02 |
3 | 1 | \) 1061.11 | \( 42.44 | \) 1061.11 | 1103.54 |
Spice asks Meyers (see the previous problem below) to quantify price changes from changes in interest rates. To illustrate, Meyers computes the value change for the fixed-rate note in the table. He assumes an increase in the interest rate level of 100 basis points. Using the information in the table, what is the predicted change in the price of the fixed-rate note?
Frank Meyers, CFA, is a fixed-income portfolio manager for a large pension fund. A member of the Investment Committee, Fred Spice, is very interested in learning about the management of fixed-income portfolios. Spice has approached Meyers with several questions. Specifically, Spice would like to know how fixed-income managers position portfolios to capitalize on their expectations of future interest rates.
Meyers decides to illustrate fixed-income trading strategies to Spice using a fixed rate bond and note. Both bonds have semi-annual coupon periods. All interest rate (yield curve) changes are parallel unless otherwise stated. The characteristics of these securities are shown in the following table. He also considers a nine-year floating-rate bond (floater) that pays a floating rate semi-annually and is currently yielding 5%.
Spice asks Meyers about how a fixed-income manager would position his portfolio to capitalize on expectations of increasing interest rates. Which of the following would be the most appropriate strategy?
a. Shorten his portfolio duration.
b. Buy fixed-rate bonds.
c. Lengthen his portfolio duration.
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