# HW2_answers - Chapter 7 1 If interest rates go up bond...

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Chapter 7: 1. If interest rates go up, bond prices _________. (A) go down (B) go up (C) stay the same (D) it is impossible to predict what will happen 2. Higher interest rates lead stock investors to demand _______ return from stock investment, which in turn result in _________ stock prices. (A) higher; higher (B) higher; lower (C) lower; higher (D) lower; lower Use the following information to answer questions 25 thorough 26: Suppose a company is going to issue new bond which has a 6% coupon, 30-year maturity with par value of \$1000 paying 60 semiannual coupon payments of \$30 each. Assume that the market interest rate for this bond is 6% 3. What is the price of the bond? Price= t=1 60 \$ 30 + \$ 1000 (1.03) t (1.03) 60 = \$30*Annuity factor (3%, 60) + \$1000*PV factor (3%, 60) = 830+170=\$1000 4. What would be the price of the bond if the market interest rate were to rise to 10%? Price= \$30*Annuity factor(5%, 60) + \$1000*PV factor(5%, 60) = 30*18.929+1000*0.054=567.87+54=622 5. As the profits of a corporation increase, the coupon payments on bonds increase. (A) True (B) False (C) Uncertain <Answer> B: Bondholders are fixed claimholders 6. Suppose you expect that the market interest rate will increase in the near future. What do you expect to happen to YTM of T-bond? (A) YTM will fall. (B) YTM will increase .

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(C) YTM will not be affected. (D) Uncertain. <Answer> B: YTM is also a kind of market interest rate. Alternatively, you can think in this way: decreases in market interest rate will increase bond price, which implies decreasing discount rate (YTM). 7. If you believe that the economy will fall into recession in the near future. Which of the following securities will you choose? (A) stock (B) a short-term T-bond (C) a medium-term T-bond (D) a long-term T-bond <Answer> D <Answer> Bond price is NEGATIVELY related to interest rate, and its sensitivity to the changes in interest rate INCREASE as the maturity of bond becomes longer. 8. You are given two bonds. Bond A has a 6% coupon rate paid semi-annually, a 20-year maturity, and is currently selling at \$1,000. Bond B has a 6% coupon rate paid semi- annually, a 10-year maturity, and is currently selling at \$1,000. If interest rates rise over the next year, what will happen to the prices of these two bonds, all else held constant? a. Both bonds will fall in price but Bond A’s price will fall by a larger amount than Bond B’s price. b. Both bonds will fall in price but Bond B’s price will fall by a larger amount than Bond A’s price. c. Bond A’s price will fall while Bond B’s price will rise. d. Bond B’s price will fall while Bond A’s price will rise. e. None of the above. <Answer> First, there is an inverse relationship b/w present values and the interest rate. Therefore, if interest rates rise, the value of both bonds will fall. Second, both bonds pay the same coupon rate, but Bond A has a loner
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HW2_answers - Chapter 7 1 If interest rates go up bond...

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