Ch 3 sol - Answers to End-of-Chapter Questions 1. $2000 =...

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Answers to End-of-Chapter Questions 1. $2000 = $100/(1 + i ) + $100/(1 + i ) 2 + ⋅ + $100/(1 + i ) 20 + $1000/(1 + i ) 20 . 2. 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. 3. No. If interest rates rise sharply in the future, long-term bonds may suffer such a sharp fall in price that their return might be quite low, possibly even negative. 4. People are more likely to buy houses because the real interest rate when purchasing a house has fallen from 3 percent ( = 5 percent –2 percent) to 1 percent ( = 10 percent –9 percent). The real cost of financing the house is thus lower, even though mortgage rates have risen. (If the tax deductibility of interest payments is allowed for, then it becomes even more likely that people will buy houses.) Quantitative Problem 1. Calculate the present value of $1,000 zero-coupon bond with 5 years to maturity if the required annual interest rate is 6%. Solution: PV = FV /(1 + i ) n , where FV = 1000, i = 0.06, n = 5 PV = 747.25 grand prize is 2. A lottery claims its grand prize is $10 million, payable over 20 years at $500,000 per year. If the first payment is made immediately, what is this grand prize really worth? Use a discount rate of 6%. Solution: This is a simple present value problem. Using a financial calculator: N = 20; PMT = 500,000; FV = 0; I = 6%; Pmts in BEGIN mode. Compute PV : PV = $6,079,058.25 3. Consider a bond with a 7% annual coupon and a face value of $1,000. Complete the following table: Years to Maturity Discount Rate Current Price 3 5 3 7 6 7 9 7 9 9
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10 Mishkin/Eakins • Financial Markets and Institutions, Sixth Edition What relationship do you observe between yield to maturity and the current market value? Solution: Years to Maturity Yield to Maturity Current Price 3 5 $1,054.46 3 7 $1,000.00 6 7 $1,000.00 9 5 $1,142.16 9 9 $ 880.10 When yield to maturity is above the coupon rate, the band’s current price is below its face value. The opposite holds true when yield to maturity is below the coupon rate. For a given maturity, the bond’s current price falls as yield to maturity rises. For a given yield to maturity, a bond’s value rises as its maturity increases. When yield to maturity equals the coupon rate, a bond’s current price equals its face value regardless of years to maturity. 4.
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This note was uploaded on 10/16/2011 for the course FINANCE 101 taught by Professor Sanghoonlee during the Three '11 term at University of Wollongong, Australia.

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Ch 3 sol - Answers to End-of-Chapter Questions 1. $2000 =...

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