Problems Chapter 17 & 18:

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Problems chp. 17

1. An investor in the 28 percent tax bracket is trying to decide which of two bonds to purchase.

One is a corporate bond carrying an 8 percent coupon and selling at par. The other

is a municipal bond with a 5 percent coupon, and it, too, sells at par. Assuming all other

relevant factors are equal, which bond should the investor select?

4. The Shamrock Corporation has just issued a $1,000 par value zero-coupon bond with an 8

percent yield to maturity, due to mature 15 years from today (assume semiannual

compounding).

a. What is the market price of the bond?

b. If interest rates remain constant, what will be the price of the bond in three years?

c. If interest rates rise to 10 percent, what will be the price of the bond in three years?

Problems chp. 18

7.

a. Using the information in the following table, calculate the projected price change for

Bond B if the yield to maturity for this bond falls by 75 basis points.

b. Describe the shortcoming of analyzing Bond A strictly to call or to maturity. Explain

an approach to remedy this shortcoming.

LAUREN CORPORATION BOND INFORMATION (AS OF 2012)

Bond ABond B

(Callable) (Noncallable)

Maturity2022 2022

Coupon 11.50% 7.25%

Current price125.75 100.00

Yield to maturity7.70% 7.25%

Modified duration to maturity6.20 6.80

Convexity to maturity 0.500.60

Call date 2016

Call price 105

Yield to call 5.10%

Modified duration to call 3.10

9. The following table shows yields to maturity on U.S. Treasury securities as of January 1,

2011:

Term to Maturity Yield to Maturity

1 year3.50%

2 years 4.50%

3 years5.00%

4 years5.50%

5 years6 .00%

10 years6.60%

a. Based on the data in the table, calculate the implied forward one-year rate of interest

at January 1, 2014.

b. Describe the conditions under which the calculated forward rate would be an unbiased

estimate of the one-year spot rate of interest at January 1, 2014.

Assume that one year earlier, at January 1, 2010, the prevailing term structure for U.S. Treasury

securities was such that the implied forward one-year rate of interest at January 1,

2014, was significantly higher than the corresponding rate implied by the term structure at

January 1, 2011.

c. On the basis of the pure expectations theory of the term structure, briefly discuss two

factors that could account for such a decline in the implied forward rate.

Multiple-scenario forecasting frequently makes use of information from the term structure

of interest rates.

d. Briefly describe how the information conveyed by this observed decrease in the implied

forward rate for 2014 could be used in making a multiple-scenario forecast.