1. Building on the example we reviewed in class, calculate the monthly payment on a $425,000 mortgage with the following characteristics: 7.1% rate, 30-year mortgage (360 payments with 12 payments per year). Keep in mind that the loan will be fully paid off when the last regular payment is made (i.e., the future value, FV, is zero).
2. Using the amortization feature (AMORT) for the loan above, how much will you owe after five years (the balance after 60 payments)?
3. To put today's housing market in perspective, rerun the above (questions 1 & 2) analysis. If the interest rate was 2.9% (instead of 7.1%) and the mortgage amount was $350,000. As you compare your answers (the payment and loan balance), remember that this could have been the same house...just two years ago!
4. Switching to the bond (BOND) function, calculate the price of a bond purchased on June 14, 2021 maturing on October 1, 2025 paying a coupon of 3% with a yield of 3.5% (note that days are "actual" (ACT) and the bond pays semiannual coupons (2 payments/year). Assume the bond has an (original) face value of $1000.
5. What is the accrued interest (AI) for the bond above? Briefly explain what this means in relation to the coupon dates on the bond.
6. What is the duration (DUR) for the bond above? Briefly explain duration and how it would change if the coupon rate were higher. How would it change if the bond had a later maturity date (longer maturity)? Why? Hint: One way to verify your answer is to change the rates and dates of the bond.
7. Explain the relationship between interest rate risk and duration. To answer this question, you might go through a few "what if" scenarios to see what effect a 1% change in required return (yield) has on the price of bonds with different maturities and/or coupon rates. You should find that the price of bonds with longer durations will change more than those with shorter durations for any given change in rates.
8. Why is duration a better measure of interest rate risk than maturity?