Recitation4_Chapter6_MB_fa11

Recitation4_Chapter6_MB_fa11 - working with You can think...

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Money and Banking (Fall 2011) Recitation #4 on Thursday (10/6) Chapter 6: Part 1: Questions 3 and 11 from chapter 6 will be used to guide the discussion on the risk structure of interest rates. Part 2: Suppose a firm issued a 10% coupon bond 20 years ago. The bond now has 5 years left until its maturity date and is currently selling at $950. However, the firm is having financial difficulties. Investors believe that the firm will be able to make its remaining interest payments, but that at the maturity date, the firm will be forced into bankruptcy. As a result, bondholders expect to receive only 70% of the payments at the maturity date. a. Write out the equation for the “stated YTM,” which is the equation you have been
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Unformatted text preview: working with. You can think of this as the equation that will determine the official published YTM. b. Now write out the equation for the “expected YTM,” which is the equation that takes into account that investors actually expect to receive only 70% of the par value and coupon payment at maturity. c. Which YTM is higher? Why? d. Suppose instead that the YTM is fixed at the “stated YTM” from part a. What will happen to the price of the bond, given the risk of default of the final payment? Part 3: The following chart is the yield curve from October 2007. Based on the expectations hypothesis, what does the above yield curve tell you about short-term interest rates over the next 30 years?...
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