Explaining the Future The president of the United States announces in a press conference that he will fight the higher inflation rate with a new anti-inflation program. Predict what will happen to interest rates if the public believes him. The chairman of the Fed announces that interest rates will rise sharply next year, and the market believes him. What will happen to today’s interest rate on AT&T bonds, such as the 8 1/8s of 2022? Predict what will happen to interest rates if the public suddenly expects a large increase in stock prices? Predict what will happen to interest rates if prices in the bond market become more volatile. Chapter 4 Quantitative Problems You own a $1,000-par zero-coupon bond that has 5 years of remaining maturity. You plan on selling the bond in one year, and believe that the yield to maturity next year will have the following probability distribution Probability Yield % 0.1 6.60% 0.2 6.75% 0.4 7.00% 0.2 7.20% 0.1 7.45% What is your expected price when you sell the bond? What is the standard deviation of the bond price? Consider a $1,000-par junk bond paying a 12% annual coupon with 2 years to maturity. The issuing company has a 20% chance of defaulting this year in which case the bond would not pay anything. If the company survives the first year, paying the annual coupon payment then it has a 25% chance of defaulting in the second year. If the company defaults in the second year then neither the final coupon payment nor the par value of the bond will be paid What price must investors pay for this bond to expect a 10% yield to maturity? At that price what is the expected holding period return and standard deviation of returns? Assume that periodic cash flows are reinvested at 10% Last month, corporations supplied $250 billion in 1 year discount bonds to investors at an average market rate of 11.8%. This month, an additional $25bn in one-year discount bonds became available, and market rates increased to 12.2%. Assuming that the demand curve remained constant, derive a linear equation for the demand for bonds, using prices instead of interest rates. An economist has concluded that, near the point of equilibrium, the demand curve and supply curve for 1-year discount bonds can be estimated using the following equations
Explaining the Future The president of the United States announces in a press conference that he will fight the higher inflation rate with a new anti-inflation program. Predict what will happen to interest rates if the public believes him. The chairman of the Fed announces that interest rates will rise sharply next year, and the market believes him. What will happen to today’s interest rate on AT&T bonds, such as the 8 1/8s of 2022? Predict what will happen to interest rates if the public suddenly expects a large increase in stock prices? Predict what will happen to interest rates if prices in the bond market become more volatile. Chapter 4 Quantitative Problems You own a $1,000-par zero-coupon bond that has 5 years of remaining maturity. You plan on selling the bond in one year, and believe that the yield to maturity next year will have the following probability distribution Probability Yield % 0.1 6.60% 0.2 6.75% 0.4 7.00% 0.2 7.20% 0.1 7.45% What is your expected price when you sell the bond? What is the standard deviation of the bond price? Consider a $1,000-par junk bond paying a 12% annual coupon with 2 years to maturity. The issuing company has a 20% chance of defaulting this year in which case the bond would not pay anything. If the company survives the first year, paying the annual coupon payment then it has a 25% chance of defaulting in the second year. If the company defaults in the second year then neither the final coupon payment nor the par value of the bond will be paid What price must investors pay for this bond to expect a 10% yield to maturity? At that price what is the expected holding period return and standard deviation of returns? Assume that periodic cash flows are reinvested at 10% Last month, corporations supplied $250 billion in 1 year discount bonds to investors at an average market rate of 11.8%. This month, an additional $25bn in one-year discount bonds became available, and market rates increased to 12.2%. Assuming that the demand curve remained constant, derive a linear equation for the demand for bonds, using prices instead of interest rates. An economist has concluded that, near the point of equilibrium, the demand curve and supply curve for 1-year discount bonds can be estimated using the following equations
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