Chapter 3: Q11-2B (page 360)
You predict that interest rates are about to fall. Which bond will give you the highest capital gain?
a. Low coupon, long-maturity
b. High coupon, short maturity
c. High coupon, long maturity
d. Zero coupon, long maturity
a. Low coupon, long-maturity
Over 30 million students worldwide already upgrade their learning with Vaia!
All the tools & learning materials you need for study success - in one app.
Get started for free
Question: The following table contains spot rates and forward rates for three years. However, the labels got mixed up. Can you identify which row of the interest rates represents spot rates and which one the forward rates?
Year | 1 | 2 | 3 | |
Spot rate of Forward rates? | 10.00% | 12.00% | 14.00% | |
Spot rate of Forward rates? | 10.00% | 14.0364% | 18.1078% |
Sandra Kapple presents Maria Van Husen with a description, given in the following exhibit, of the bond portfolio held by the Star Hospital Pension Plan. All securities in the bond portfolio are non-callable U.S. Treasury securities.
STAR HOSPITAL PENSION PLAN BOND PORTFOLIO
Par value (in US \() | Treasury security | Market value (in US \)) | Current Price | Up 100 basis points | Down 100 basis points | Effective duration |
\(48,000,000 | 2.375% due 2010 | \)48,667,680 | $101.391 | 99.245 | 103.595 | 2.15 |
50,000,000 | 4.75% due 2035 | 50,000,000 | 100.000 | 86.372 | 116.887 | |
98,000,000 | Total bond portfolio | 98,667,680 | ------- | -------- | ------- | -------- |
a. Calculate the effective duration of each of the following:
i. The 4.75% Treasury security due 2035
ii. The total bond portfolio
b. Van Husen remarks to Kapple, “If you changed the maturity structure of the bond portfolio to result in a portfolio duration of 5.25, the price sensitivity of that portfolio would be identical to the price sensitivity of a single, non-callable Treasury security that has a duration of 5.25.” In what circumstance would Van Husen’s remark be correct?
Noah Kramer, a fixed-income portfolio manager based in the country of Sevista, is considering the purchase of a Sevista government bond. Kramer decides to evaluate two strategies for implementing his investment in Sevista bonds.
Table 11.6 gives the details of the two strategies, and Table 11.7 contains the assumptions that apply to both strategies.
Before choosing one of the two bond investment strategies, Kramer wants to analyze how the market value of the bonds will change if an instantaneous interest rate shift occurs immediately after his investment.
The details of the interest rate shift are shown in Table 11.8. Calculate, for the instantaneous interest rate shift shown in Table 11.8, the percent change in the market value of the bonds that will occur under each strategy.
Question: Masters Corp. issues two bonds with 20-year maturities. Both bonds are callable at \(1,050. The first bond is issued at a deep discount with a coupon rate of 4% and a price of \)580 to yield 8.4%. The second bond is issued at par value with a coupon rate of 8.75%.
a. What is the yield to maturity of the par bond? Why is it higher than the yield of the discount bond?
b. If you expect rates to fall substantially in the next two years, which bond would you prefer to hold?
c. In what sense does the discount bond offer “implicit call protection”?
A bond currently sells for \(1,050, which gives it a yield to maturity of 6%. Suppose that if the yield increases by 25 basis points, the price of the bond falls to \)1,025. What is the duration of this bond?
What do you think about this solution?
We value your feedback to improve our textbook solutions.
