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Bond Problem Assignment

This document is a bond problem assignment for Finance 3650, due on October 4, 2021, requiring students to solve various finance-related problems and show their work. It includes calculations for the Fisher Effect, Price Index comparison, interest rates for a U.S. Treasury Bill, and Yield to Maturity for a Treasury Bond. The assignment emphasizes the importance of submitting detailed answers rather than just final results to receive credit.

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8 views3 pages

Bond Problem Assignment

This document is a bond problem assignment for Finance 3650, due on October 4, 2021, requiring students to solve various finance-related problems and show their work. It includes calculations for the Fisher Effect, Price Index comparison, interest rates for a U.S. Treasury Bill, and Yield to Maturity for a Treasury Bond. The assignment emphasizes the importance of submitting detailed answers rather than just final results to receive credit.

Uploaded by

zack.calhoun
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 DOCX, PDF, TXT or read online on Scribd
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Bond Problem Assignment Finance 3650 Ross N.

Dickens Fall 2021

Name: Zachary Calhoun

This assignment is due by 8:00am on Monday, October 4, 2021. Submit via Blackboard. Point
values noted for each problem (plus bonus, when applicable).

Directions: work the problems presented below. You may work together, but each student is to
submit his/her own answer sheet and must show/explain all work. Just submitting an answer
(say “6.04%”) with no support for how you came to such an answer will earn no credit.

1) (Fisher Effect; 20 points) You have an estimate of 4.5% for the real rate of return in the
economy and an inflation prediction of 3.4%. According to the Fisher Effect, what is the
estimated nominal rate of interest for this economy? (You may provide just the
approximate estimated rate. You may also include the full estimate for bonus points.) As
a first step, provide the formula needed to calculate this problem.

Formula for Fisher Effect: i  r + p^e, where “i” is the nominal interest rate, “r” is the
real rate of interest, and “p^e” is the expected rise in prices (inflation rate).
 i  4.5 + 3.4 = 7.90
 i (nominal interest rate)  7.90% (approximately)

2) (Price Index; 30 points) You started a job August 2021 paying $50,000 per year. Your
parent started working at a comparable job in May 1996 for $28,500. If the CPI-U price
index in May 1996 was 156.6 and the CPI-U index was 273.0 in August 2021, which one
of you will be comparably better paid, all else held equal?
(Note: you may earn bonus points by comparing the numbers as of 1996 and as of 2021.)

Formula for Price Index comparison: D1 = D2 (PI1) / PI2), where D1 = $28,500, D2 =


$50,000, PI1 = 156.6 (CPI-U 1996), and PI2 = 273.0 (CPI-U Aug. 2021)
 $28,500 = $50,000 (156.6) / (273.0)
 $28,500 = $28,681.32
 $28,500  $28,681.32
 All else held equal, the person being paid $50,000 in August of 2021 would be
slightly better compensated than someone making $28,500 in 1996. The person
in 2021 would make about 0.64% more than their parent in 1996.

3) (50 points) You are considering buying a U.S. Treasury Bill with 90 days to maturity.
The current price is $988.00 (with the maturity value being $1,000). Calculate what the
interest rate would be (to the nearest basis point) if the Bill were priced using the
following interest rate quotation processes. (Note: this price is low for the current interest
rate environment.)
a. Simple interest (holding period yield)

Simple Interest rate formula: (Pm – Po) / Po, where Pm = par value and Po =
purchase price.
 (1000 – 988.00) / 988.00
 (1000 – 988.00) / 988.00 = 0.0121 or 1.21%
 The simple interest rate for this Treasury bill would be 1.21%

b. Bank Discount Yield

Bank Discount Yield (BDY) formula: [(Pm – Po / Pm) * (360/n)], where Pm = par
value, Po = purchase price, and n = time to maturity
 [(1000 – 988.00 / 1000) * (360/90)]
 [(0.0120) * (4)] = 0.0480 or 4.80%
 The bank discount yield for this Treasury bill would be 4.80%

c. Money Market 360-Day Rate

Money Market 360-Day Rate formula: [(Pm – Po / Po) * (360/n)], where Pm = par
value, Po = purchase price, and n = time to maturity
 [(1000 – 988.00 / 988.00) * (360/90)]
 [(0.0121) * (4)] = 0.0484 or 4.84%
 The money market 360-day rate for this Treasury bill would be 4.84%

d. Money Market 365-Day Rate

Money Market 365-Day Rate formula: [(Pm – Po / Po) * (365/n)], where Pm = par
value, Po = purchase price, and n = time to maturity
 [(1000 – 988.00 / 988.00) * (365/90)]
 [(0.0121) * (4.0556)] = 0.0491 or 4.91%
 The money market 365-day rate for this Treasury bill would be 4.91%

e. Effective Annual Rate (APY)

Effective Annual Rate (APY) formula: {1 + [(Pm - Po) / Po]}365/n - 1, where Pm = par
value, Po = purchase price, and n = time to maturity
 {1 + [(1000 – 988.00) / 988.00]}365/90 – 1
 {1 + [0.0121]} 4.0556 – 1
 1.01214.0556 – 1 = 0.0500 or 5.00%
 The effective annual rate (APY) for this Treasury bill is 5.00%

Bonus
1) (YTM; 15 points) The current price of a 30-year, 4.6% coupon U.S. Treasury Bond with
eight (8) years to maturity is $1,112. Assuming the usual maturity value of $1,000 and
semi-annual coupon payments, what is the Yield to Maturity (YTM) for this bond?

Bond Formula Po = I[1-(1+i)-n] + M(1+i)-n


i
Step 1: set up the equation needed to solve this problem.
Step 2: provide an estimate as to what the YTM should be based (and explain that
estimate in terms of the current price).
Step 3: find the value (using a financial calculator, Excel, or trial and error) to the nearest
basis point (i.e. 0.01%).

2) You look at data in the U.S. Treasurys yield curve, (yes, The Wall Street Journal spells
as “Treasurys”) and find the following date embedded in the curve:

1-year rate = 2.00%


2-year rate = 2.50%
3-year rate = 2.75%
4-year rate = 3.25%

a. (10 points) Using the Pure Expectations Theory (PET), what is the expected 1-year
rate in one year?

b. (10 points) What would PET expect the 1-year rate to be in three years?

c. (20 points) If the Liquidity Premium to invest for two years instead of just for one
year were 0.40%, and using the Liquidity Premium Hypothesis concepts, what would
that theory’s expectation of the 1-year rate in one year be?

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