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Weekly Exercise Set 6ww

This document contains a series of exercises related to bond pricing and yields: 1. It provides the prices of several zero-coupon bonds and asks to calculate their yields to maturity and implied forward rates. 2. It gives spot and forward rates and asks to price a 3-year coupon bond. 3. It provides information about a coupon bond and asks to calculate its yield to maturity and return. 4. It compares the prices and returns of several bonds with different coupon rates over a 1-year horizon.

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Johny
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55 views3 pages

Weekly Exercise Set 6ww

This document contains a series of exercises related to bond pricing and yields: 1. It provides the prices of several zero-coupon bonds and asks to calculate their yields to maturity and implied forward rates. 2. It gives spot and forward rates and asks to price a 3-year coupon bond. 3. It provides information about a coupon bond and asks to calculate its yield to maturity and return. 4. It compares the prices and returns of several bonds with different coupon rates over a 1-year horizon.

Uploaded by

Johny
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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Investments

Fall 2020
Weekly Exercises – Set 6

1. The following is a list of prices for zero-coupon bonds of various maturities.


Calculate the yields to maturity of each bond and the implied sequence of forward
rates.

Maturity (years) Price of Bond

1 $955.00

2 $901.47

3 $838.62

4 $779.89

2. Consider the following spot and forward rates:

1y Spot 4%

One-year forward rate one year from 5.5%


today

One-year forward rate two years 8.5%


from today

What is the price of a 3-year bond that has a 5% coupon rate paid annually and a
face value of $1000?
3. Consider a 9% coupon bond selling for $964.8 with 3 years until maturity making
annual coupon payments. The interest rates in the next 3 years will be, with
certainty, r1=6%, r2=8%, and r3=9%. Calculate the yield to maturity and realized
compound return of the bond.

4. Assume you have a one-year investment horizon and are trying to choose among
three bonds. All the bonds have the same degree of default risk and mature in 8
years. The first is a zero-coupon bond that pays €1000 at maturity. The second
has an 7% coupon rate and pays €70 coupon once per year. The third has a 8%
coupon rate and pays €80 coupon once per year.
a. If all three bonds are now priced at yield to maturity of 6%, what are their prices?
b. If you expect their yields to maturity to be 10% at the beginning of next year, what
will their prices be then? Assume you are computing the prices after coupons have
been paid.
c. What is your holding period return on each bond if the investment horizon is 1
year?
d. Decompose the holding period return, over the first year, into return coming from
the coupon (current yield) and price changes (capital gain).

5. A coupon bond pays annual interest, has a par value of $1,000, matures in 5 years,
has a coupon rate of 10% and has a YTM of 11%. What is the current yield of this
bond? Note: A bond's current yield is defined as the ratio between the
investment's annual income (including interest payments and, if any, dividends
payments) and the current price of the security.

6. Ceteris paribus, the price and yield on a bond are


a. Positively related
b. Negatively related
c. Sometimes positively and sometimes negatively related
d. Not related
e. Indefinitely related
7. A coupon bond that pays interest annually is selling at par of $1,000, matures in
5 years and has a coupon rate of 10%. The YTM on this bond is
a. 8.0%
b. 8.3%
c. 9.0%
d. 10.0%
e. None of the options above

Use the information in the table to answer questions 8 and 9.

1 2 3 4 5

Strip Price 99 96 94 91 88

8. What is the yield to maturity (YTM) of a 5-year coupon bond with a coupon rate
of 5% paid annually?

9. The yield to maturity is not the same as the expected return in each year over the
life of a bond except when one holds a zero-coupon bond until maturity. Expected
return depends on yield of bonds with shorter maturities, which for coupon bonds
means the rate at which coupons can be reinvested. We explore this in the
following set of questions. Assume the expectations hypothesis of the term
structure is correct.
a. Compute the spot rates from the strip prices.
b. What is the no-arbitrage price of a 5-year coupon bond paying 5% annually
with a par value of €1000?
c. Compute the expected return if you purchase the coupon bond at the no-
arbitrage price and expect to hold it for one year. In other words, what is the
expected return after the 1st year?
d. Repeat c for the 2nd, 3rd, 4th and 5th years if you similarly buy at the beginning
of the year and expect to hold the bond for only one year.
e. What is the expected return if you buy the bond at time 0 and plan to sell in 3
years’ time?

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