# 1PracticeAnswers - Optional Practice Problems...

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Unformatted text preview: Optional Practice Problems Bonds &amp;amp; Equities ANSWERS Practice Question #1 The following table shows the prices of a sample of U.S. Treasury STRIPS in August 2006. Each STRIP makes a single payment of \$1,000 at maturity (the coupon payments have be stripped out of the bond). a. Calculate the annually compounded, spot interest rate for each year. b. Is the term structure upward- or downward-sloping or flat? c. Would you expect the yield on a coupon bond maturing in August 2010 to be higher or lower than the yield on the 2010 STRIP? d. Calculate the annually compounded, one-year forward rate of interest for August 2008. Now do the same for August 2009. Maturity Price (%) August 2007 95.53 August 2008 91.07 August 2009 86.20 August 2010 81.08 a. Spot rates: for 2007 = 4.680% n=1, PV=95.53, FV=100, solve for i for 2008 = 4.790% n=2, PV=91.07, FV=100, solve for i for 2009 = 5.075% n=3, PV=86.20, FV=100, solve for i for 2010 = 5.380% n=4, PV=81.08, FV=100, solve for i b. Upward sloping as indicated by the increase in the spot rates. c. Lower. The yield is an average of the different spot rates each year which would be lower than the 2010 interest rate. Average interest rate = (4.680+4.790+5.075+5.380)/4 = 4.9813% / 2010 interest rate = 5.380% d. 2008-2009 = 5.65% 2009-2010 = 6.31% Practice Question #2 A 10-year U.S. Treasury bond with a face value of \$10,000 pays a coupon of 5.5% (2.75% of face value every six months). The semi-annually compounded interest rate is 5.2% (a six month discount rate of 5.2/2=2.6%). a. What is the present value of the bond? = 275 1 0.026 1 (1 + 0.026) + 10,000 (1 + .026) = \$10,231.64 b. Generate a graph or table showing how the bonds present value changes for the semi- annually compounded interest rate between 1% and 15%....
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