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Chapter 8 Recommended End-of-Chapter Problems and Solutions

This document contains solutions to recommended end-of-chapter problems from a textbook. It includes calculations related to topics like municipal bonds, Treasury bonds, inflation, the national debt, and Social Security expenditures. The problems cover a range of quantitative financial concepts.

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Lao Mjie
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34 views2 pages

Chapter 8 Recommended End-of-Chapter Problems and Solutions

This document contains solutions to recommended end-of-chapter problems from a textbook. It includes calculations related to topics like municipal bonds, Treasury bonds, inflation, the national debt, and Social Security expenditures. The problems cover a range of quantitative financial concepts.

Uploaded by

Lao Mjie
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Chapter 8 Recommended End-of-Chapter Problems and Solutions

3. If a corporate bond paid 9% interest, and you are in the 28% income tax bracket,
what rate would you have to earn on a municipal bond of equivalent risk and
maturity in order to be equally well off? Given that municipal bonds are often not
easily marketable, would you want to earn a higher or lower rate than the rate you
just calculated?

The after-tax yield on the taxable corporate bond is 6.48% = 9%(1 - 0.28) and is the
comparable rate of a tax-free municipal bond. If the muni were less marketable, investors
would pay less or require a higher rate of return (i.e., above 6.48%).

a. Suppose that when issued, a dealer buys $500 million in face value of 5% coupon 20-
year U.S. Treasury bonds for the purposes of stripping into zero coupon bonds.
(a) How many new CUSIP numbers would the dealer request?
(b) How many $1,000 zero coupon bonds with 7.5 years to maturity would be
formed?
(c) How many $1,000 zero coupon bonds with 20.0 years to maturity would be
formed?
(d) In total, how many $1,000 zero coupon bonds are formed?
(e) What is the total in face value of all zero coupon bonds?

41 (because STRIP securities formed from last coupon payment and payment of par
take different CUSIP numbers)
coupon income each 6 months = (500 million)(.025) = $12.5 million or 12,500
$1,000 bonds
$500 million + $12.5 million = $512.5 million or 512,500 $1,000 bonds.
40(12,500) + 500,000 = 1,000,000
$1 billion

b. With reference to the CPI slide, (a) how much inflation occurred over the period
6/30/09 and 6/30/13, and (b) how much inflation was there over the first 10 months
of 2008?

(a) (233.504 - 215.693) / 215.693 = 8.2576%


(b) (216.573 - 210.0) / 210.0 = 3.1300%

c. How much inflation was there between the end of September 2008 and the end of
September 2012?

(231.407 218.783)/218.783 = 5.7701%

d. Consider a 1.6% coupon rate TIPS issued on the last day of March 2007. What was
its adjusted principal on the last day of September 2011?

1000 + 1000*(226.889 205.352)/205.352 = 1104.88


e. The National Debt Held by the Public on 9/30/16 was $14.2 trillion. Roughly, how
much of this would be in the form of T-bills, T-notes, T-bonds, and TIPS?

T-bills: 14.2 (.10) = $1.42 trillion


T-notes: 14.2 (.60) = $8.52 trillion
T-bonds: 14.2 (.15) = $2.13 trillion
TIPS: 14.2 (.10) = $1.42 trillion

f. Assume a Total National Debt of $20 trillion. If interest on the National Debt were to
rise and average 2.9%, what would be the total annual interest on this debt? How
much would this be per capita?

annual interest = 20(.029) = $580 billion


580000/320 = $1,813 per person

g. At what marginal tax rate would a 5.9% taxable bond be comparable to a similar
4.7% municipal bond?

Rearranging the expression on the Municipal Bonds slide, we have

(ibt iat)/ibt = (5.9 4.7)/5.9 = 1.2/5.9 = 20.3%

h. Let us divide municipal debt into state and local. With regard to municipal debt at
the state level, Georgia is the 2nd least debt-ridden state. Georgia state debt is only
about $15 billion. Given that the population of Georgia is 10.2 million, (a) how
much state debt is that per citizen of Georgia? (b) If the average interest rate on
this debt is 2.7%/year, how much must be collected in state taxes each year per
citizen of Georgia to pay the interest on this debt?

$15 billion/10.2 million = $1,470.59 per person


.027($1,470.59)= $39.71 per person per year

However, this is only part of the picture because we have not included municipal debt at
the local level.

i. In 2015, OASI expenditures were $750 billion and administrative expenses were $3.4
billion. Suppose that in 2015 the average balance in the OASI Trust Fund was $2.74
trillion. Then for 2015, administrative expenses were what percentage of: (a) the
average balance in the OASI Trust Fund, and (b) OASI expenditures? Express in
basis points.

(a) 0.0034/2.740 = 0.001241 = 0.1241% = 12.41 basis points


(b) 0.0034/0.750 = 0.004533 = 0.4533% = 45.33 basis points

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