A risk-free zero coupon bond pays $1,000 at the end of six years. (a) The risk-free...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
A risk-free zero coupon bond pays $1,000 at the end of six years. (a) The risk-free rate is currently 10% effective annual. What should the current price of the bond be? (b) Suppose the bond currently costs $500. Describe an arbitrage to take advantage of any discrepancy you see. What will you buy? What will you sell? What are your cashflows today and in the future? For the remaining sub-questions, assume that there are no arbitrage opportunities. (c) Joan buys the bond today after arbitrage by market participants has restored its price to what it should be. She intends to hold it till maturity, and to receive the payment of $1,000. What will her HPR be? What will her annualized HPR (AHPR) be? (d) So she's bought the bond, and holds it for four years. Then, without warning, her son decides to go to medical school and she has to sell all her investments to pay the fees. i. Suppose the risk-free rate on the date she sells the bond is 6% effective annual. What is the price she sold the bond for?¹ What was the HPR she made over the four years? What was the AHPR she made? ii. Suppose instead that the risk-free rate on the date she sells the bond is 10% effective annual. What is the price she sold the bond for? What was the HPR she made? What was the AHPR she made? iii. Evaluate the truth of this statement: "At the time Joan bought the bond, the interest rate in the market was 10%, and the bond was priced so that we will make 10% per year on it. We already know that the payment the bond makes is risk-free. Therefore Joan is guaranteed to make 10% on her investment in this bond." Under what conditions is this statement true? Under what conditions can this statement be false? A risk-free zero coupon bond pays $1,000 at the end of six years. (a) The risk-free rate is currently 10% effective annual. What should the current price of the bond be? (b) Suppose the bond currently costs $500. Describe an arbitrage to take advantage of any discrepancy you see. What will you buy? What will you sell? What are your cashflows today and in the future? For the remaining sub-questions, assume that there are no arbitrage opportunities. (c) Joan buys the bond today after arbitrage by market participants has restored its price to what it should be. She intends to hold it till maturity, and to receive the payment of $1,000. What will her HPR be? What will her annualized HPR (AHPR) be? (d) So she's bought the bond, and holds it for four years. Then, without warning, her son decides to go to medical school and she has to sell all her investments to pay the fees. i. Suppose the risk-free rate on the date she sells the bond is 6% effective annual. What is the price she sold the bond for?¹ What was the HPR she made over the four years? What was the AHPR she made? ii. Suppose instead that the risk-free rate on the date she sells the bond is 10% effective annual. What is the price she sold the bond for? What was the HPR she made? What was the AHPR she made? iii. Evaluate the truth of this statement: "At the time Joan bought the bond, the interest rate in the market was 10%, and the bond was priced so that we will make 10% per year on it. We already know that the payment the bond makes is risk-free. Therefore Joan is guaranteed to make 10% on her investment in this bond." Under what conditions is this statement true? Under what conditions can this statement be false?
Expert Answer:
Answer rating: 100% (QA)
a To determine the current price of the bond we can use the present value formula Current Price Future Value 1 rn Where Future Value 1000 the amount the bond pays at the end of six years r 10 effectiv... View the full answer
Related Book For
Introduction to Operations Research
ISBN: 978-1259162985
10th edition
Authors: Frederick S. Hillier, Gerald J. Lieberman
Posted Date:
Students also viewed these finance questions
-
K Graph the given system of inequalities. x + y 49 x -y 7
-
KYC's stock price can go up by 15 percent every year, or down by 10 percent. Both outcomes are equally likely. The risk free rate is 5 percent, and the current stock price of KYC is 100. (a) Price a...
-
Planning is one of the most important management functions in any business. A front office managers first step in planning should involve determine the departments goals. Planning also includes...
-
Telstar Limited was incorporated on 2 January 2015. On 3 January 2015, the company ordered plant from Germany at a cost of E1 million. The plant was loaded free on board in Hamburg on 1 March 2015,...
-
If the observed and expected frequencies for a chi-square goodness-of-fit test, a chi-square independence test, or a chi-square homogeneity test matched perfectly, what would be the value of the test...
-
For each of the plates and loadings shown, determine the reactions at A and B. (a) (b) 50 lb 4 in 40 lb 10 in 20 in. 50 lb 40 lb 10 in. 30 20 in
-
On July 1, Chi Kong creates a petty cash fund with a balance of $300. During July, Elise Sautter, the fund custodian, signs the following petty cash tickets: Petty Cash Ticket Number 101 102 103...
-
James Ferguson operates Jims 11-E Auto Sales in Jonesborough, Tennessee, as a sole proprietorship. In 1999, Consumers Insurance Co. issued a policy to Jim Ferguson, Jims 11E Auto Sales covering Owned...
-
Question 7 Find 2 0 S S 0 3 (2x+5y) dxdy < >
-
Coca Cola (KO) price is $61/share. The company is expected to pay dividend of $1.7/share next year. (In reality, dividends are paid quarterly. In this question we will assume for simplicity that all...
-
Jennifer separated from Mark and their marriage fell apart, but they did not divorce. Jennifer has been living with Fawad for 24 consecutive months as her common life partner. Can Fuad support...
-
Think about someone whom you find to be an excellent speaker. What makes this speaker excellent? How does he or she structure introductions and conclusions? Does he or she give attention to language...
-
Find a YouTube video of a global multimedia presentation (e.g., TED Talk, RSA speech). Write a brief summary about how one of your personal speech designs might be altered when tailored to a global...
-
What are the legal consequences of violating Canadas anti-spam legislation?
-
Have you ever seen a speaker reading a speech? What was your impression of that speaker? How did you feel as an audience member?
-
Why is it important to ascertain which legal system governs a contract?
-
Two buses leave towns 447 miles apart at the same time and travel toward each other. One bus travels 13(mi)/(h) slower than the other. If 3 hours, what is the rate of each bus?
-
The diagram shows the two forces acting on a small object. Which of the following is the resultant force on the object? A. 8 N downwards B. 8 N upwards C. 2 N downwards D. 2 N upwards 3 N 5 N
-
Reconsider the example illustrating the use of chance constraints that was presented in Sec. 7.5. The concern is that there is some uncertainty about how much production time will be available for...
-
Five jobs need to be done on a certain machine. However, the setup time for each job depends upon which job immediately preceded it, as shown by the following table: The objective is to schedule the...
-
A large paper manufacturing company, the Quality Paper Corporation, has 10 paper mills from which it needs to supply 1,000 customers. It uses three alternative types of machines and four types of raw...
-
What is a computer service center? Are the auditors of a client that uses a service center concerned about the controls applied at the organization? Explain.
-
What is a dual-purpose test?
-
If you were preparing a credit sales system flowchart, what document would you show as: a. The source for posting debits to a customers account in the accounts receivable ledger? b. Authorization to...
Study smarter with the SolutionInn App