1. Consider a 5-year $1000 face value bond which has a 10% coupon rate.

Currently, it is thought that interest rates will remain constant at 3% for the full

five periods. Suddenly, there is 'news' that interest rates will almost certainly

rise to 5% for the last two periods. What would happen to the bond's price,

given this news? Calculate answer.

2. Consider a 10-year $1000 face value bond with a 5% coupon rate. The investor

buys the bond for $1100 but a liquidity shock forces him to sell it after two

periods for exactly the face value. Coupons are not reinvested. What is the

average annualized yield?

3. In the above, what difference in annualized yield would there be if the first

coupon was in fact reinvested at 5%?

4. Likewise, what difference would there be in annualized yield if the coupons

were not reinvested but the investor sold instead after three periods for $1050?

5. Suppose the investor managed to hold this bond to maturity. What would the

yield to maturity be?

6. Consider a 10-year $1000 face value bond with a 10% coupon rate. The

investor buys the bond for $900 and sells it for $1100 after four years. Coupons

are not reinvested. What is the average annualized return?

7. Suppose in the above that the coupons were reinvested at 10%. What would his

effective annualized yield be now?

8. Consider a 5-year, 10%, $1000 face value bond, bought for $900 at time t,

which has a price of $1000 at t+1, $1100 at t+2, $1150 at t+3, $1050 at t+4, and

$1000 at maturity. If the investor wanted to maximize his annualized return,

when should they sell this bond?

9. At the 5-year maturity date, what would you expect this annualized return to

converge to?

10. A fussy investor always wants at least 15% from every investment made. A 2-

year, $1000 face value discount (zero-coupon) bond is selling for $800. Would

they buy it?

11. An investor buys a $1000 face value, 10-year bond with a 10% coupon rate at

par value. A week after buying it, the corporation announces severe liquidity

problems and states that there is only a 50/50 chance that the coupons and final

payment will be paid. What would be the yield on this bond, given the

announcement?

12. Explain how this announcement could make this bond receive a risk premium.

13. Suppose that an investor received 'news' that interest rates would move

increasingly downward for a number of years. Would that bias the investor to

holding more long-term bonds in his portfolio? Explain.

14. Suppose that current global uncertainty and high household debt levels now

make the probability of liquidity shocks much greater than before. Would that

actually make long-term bonds relatively less risky as compared with shortterm

bonds?

15. Consider the same $1000, 5-year, 10% coupon bond as above, bought at par.

Just after you have bought it, it recognized that there will be 5% inflation per

period, thus depreciating the real value of future coupons by 5% in each

subsequent period. How will this affect its yield to maturity, i? What will

happen if people start selling this bond?