FIN 4130hw3 - FIN 4130 Management of Financial Institutions...

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FIN 4130: Management of Financial Institutions Fall 2009 Homework 3 Due: Tuesday, September 29, 2009 Pick 5 of the 8 problems to answer and turn in at the start of class. Chapter 7: 9.) Two ten-year bonds are being considered for an investment that may have to be liquidated before the maturity of the bonds. The first bond is a 10-year premium bond with a coupon rate higher than its rate of return, and the second is a zero coupon bond that pays only a lump-sum payment after 10 years with no interest over its life. Which bond would have more interest rate risk? That is, which bond’s price would change by a larger amount for a given change in interest rates? Explain your answer. -The zero-coupon bond has more interest rate risk. The entire cash flow is received when the bond matures. Therefore, the entire cash flow is more exposed to interest rate changes over the entire life of the bond. The cash flows of the coupon-paying bond are returned periodically, which creates less exposure to interest rate changes. In effect, some of the
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