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# ps2f09 - Econ 340 Fall 2009 Problem Set 2 Chapter 3...

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Econ 340, Fall 2009 Problem Set 2 Chapter 3 : Questions 1-2, Quantitative Problems 1-3, 11, 13, 14. 1. \$ 2000 = \$100/(1 + i ) + \$100/(1 + i ) 2 + . . . + \$100/(1 + i ) 20 + \$1000/(1 + i ) 20 . 2. If there is a decline in interest rates, you would rather be holding long-term bonds because their price would increase more than the price of the short-term bonds, giving them a higher return. However, long-term bonds have a greater interest-rate risk. And, this answer really depends on the duration of the bonds, not just there term to maturity. For example, a 5 year coupon bond might be subject to less interest rate risk than a 4 year zero coupon bond. Quantitative Problems 1. Calculate the present value of \$1,000 zero-coupon bond with 5 years to maturity if the yield to maturity is 6%. Solution: PV = FV /(1 + i ) n , where FV = 1000, i = 0.06, n = 5 PV = 747.25 See Durationexamp.xls 3. Consider a bond with a 7% annual coupon and a face value of \$1,000. Complete the following table: What relationship do you observe between yield to maturity and the current market value?

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ps2f09 - Econ 340 Fall 2009 Problem Set 2 Chapter 3...

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