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Fall 2003 Exam 4

# Fall 2003 Exam 4 - Name Class Time Exam 4 Finance 4030 01...

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Name______________________________________ Class Time____________ Exam 4 Finance 4030 01 & 04 Fall 2003 December 13, 2003 The dashed line in the above chart presents hypothetical prices for a Treasury bond based upon a simple duration calculation. 1. What type of fixed income security does the solid line most likely represent? (2) 2. How could current Treasury yields and current option prices be used to help price this security? (3) 1 P r i c e e 0 -1% +4% -4% -3% -2% +3% +2% +1% Market Interest Rates vs. Today’s Levels

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3. Does the security exhibit positive convexity or negative convexity? (2) 4. What type of security is most likely represented by the above solid line? (2) 5. What is the feature of the above bond that determines the approximate point at which the price curve meets the y-axis? (2) 2 P r i c e 0 -1% +4% -4% -3% -2% +3% +2% +1% Market Interest Rates vs. Today’s Levels of 7
6. Why is an understanding of business and industry life cycles important in equity analysis? (2) 7. What are the two major contributors to a holding period return for stocks and which of the two is less reliable? (2) 8. The following is a list of prices for zero-coupon bonds of various maturities. Calculate the yields to maturity of each bond and the implied sequence of forward rates. (4) Maturity Price Yield to Forward In Years of Bonds Maturity Rate 1 943.40 xxxxxxxxxxx 2 898.47 3 847.62 3 of 4

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9. You observe the following term structure: Effective Annual YTM 1-year zero-coupon bond 6.10% 2-year zero-coupon bond 6.20% 3-year zero-coupon bond 6.30% 4-year zero-coupon bond 6.40% If you believe that the term structure next year will be the same as today’s, will the one-year or the four-year zeros provide the greater expected one-year return? (2) What if you believe the expectations hypothesis? (2) 10. How does liquidation value (often estimated as book value) get incorporated into equity valuation? (2) 11. What is the “Credit Option” inherent in a corporate bond and how does it relate to the price of the stock of the firm? (3) 4 of 8

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