Question: 1. The US Treasury (UST) issued a security which promises a cash flow of $1,000,000 in one (full) year. a) If investors require a yield

1. The US Treasury (UST) issued a security which promises a cash flow of $1,000,000 in one (full) year. a) If investors require a yield (discount rate) of 1%, what is the price (semi-annual compounding)?

-b) American Air Lines (AAL) issued the same security and its price is $980,000. What is AALs risk premium? What would AALs promised cash flow need to be in order to have the same price as the UST?

2. a) What is the price of a 20-year UST bond with a 4% coupon (face value 100) and 5% (semi-annually compounded) yield?

-b) What is the price of the same bond, but issued by AAL with a 1.5% risk premium (same compounding convention)? What would the AAL coupon need to be in order to bring it to par?

3. What would cause the yield on the AAL security in #1 or #2 to increase?

-a) an increase in the corresponding UST yield

-b) a widening in AALs risk premium

-c)either of these

4. Can the yield on the AAL bond increase even if its risk premium narrows? How?

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