Chapter 1 End of Chapter Questions
1. Fred Derf found his lost passbook for a saving account that he had opened with a $100
deposit twelve years ago. If the bank paid interest at a rate of 5% compounded annually over
this period, what should be the balanc

FINA 475
FALL 2006
EXAM II
Professor Steven Mann
Please read each question carefully before and after answering.
Please show all work to receive the maximum amount of credit.
1. Consider a 7% coupon 8-year bond with a maturity value of $100 currently valu

Total Return
Yield to maturity/yield to call are measures
of expected returns given two strong
assumptions:
1. The bond is held to maturity/call
2. All coupon payments are reinvested at
the yield to maturity/yield to call.
Total return allows the user to

Yield to Call
When a bond is callable, the practice has been to calculate a yield to call as well as a
yield to maturity. A callable bond may have a call schedule. The yield to call assumes
that the issuer will call the bend at some asSumed call date and

Yield Measures
Current yield
Yield to maturity
Yield to call/worst
Three sources of bond
returns
coupon interest payments
any capital gain (or loss) when the
bond is sold, called by the issuer or
matures
interest earned from reinvesting the
coupon p

Transforming cash flows from one form into
another.
Defining some terms
Agreement whereby two parties (called
counterparties) agree to swap interest
payments based on a notional principal
amount.
In generic swap only amount exchanged
between the parties

Measuring Interest Rate
Risk
To control interest rate risk, one
must be able to measure the
exposure.
Price/Yield Relationship for an
Option-Free Bond
Bond prices change in the opposite
direction of a change in the bond s
required yield.
Bond price vola

US Treasury
Securities
cfw_
Notes and Bonds
All securities with maturities of
two years or longer are issued as
coupon securities.
At issuance Treasury notes have a
maturity between 2 and 10 years,
and Treasury bonds have a maturity
at issuance greater th

Fixed-rate level-payment
mortgages
term of the loan is fixed
interest rate is fixed
amount of the monthly mortgage
payment is fixed for term of
loan
Steven V. Mann, PhD
1
(1)
interest of 1/12th of the
fixed annual interest rate times
the amount of the

Learning Objectives for Exam II
Explain the three sources of dollar returns from investing in bonds.
Calculate and interpret current yield.
Explain how to calculate yield to maturity with the bond pricing formula.
Explain how to calculate yield to call/yi

Formulas for First Exam
FINA 475
Present value of an annuity factor
1- 1
(1+i)n
i
Future value= (1+i)N - 1
annuity factor
i
General formula
f =
t m
(1+zm+t)m+t 1/t - 1
(1+zm)m
1

FINA 475
Spring 2916
Exam I
Steven Mann, Instructor
1.
If one-period forward rates are decreasing with maturity, the yield curve is
most likely
a. Flat
b. Upward sloping
c. Downward sloping
d. A tight spiral out to infinity.
2. Bond dealers most often quo

Yield Curve Analysis
Our analysis focuses on government
securities that have known cash flows
(no default risk, no embedded options).
Yield to maturity is the single
discount rate that equates the present
value of a bonds cash flows to its
market price.
A

Yield Measures
Current yield
Yield to maturity
Yield to call/worst
Three sources of bond
returns
coupon interest payments
any capital gain (or loss) when
the bond is sold, called by the
issuer or matures
interest earned from
reinvesting the coupon payment

Features Of Fixed Income
Securities
The beginning of wisdom is
the definition of terms.
Aristotle (a long time ago)
A fixed income security is one in which the
issuer (borrower) has agreed to make
income payments that are fixed by
contract
Term to maturit

Fixed-income Securities
FINA 475
Professor Steven Mann
Your instructor and host
Four Main Components
Fixed-income products
Analytical tools
Institutional features
Fixed-income portfolio management
Largest capital market in the world!
Fixed-income markets

Bond Valuation
Cancel and tear to
pieces that great bond
which keeps me pale.
Macbeth
Valuation of OptionFree Bonds
General Principles of Valuation:
1. Estimate the expected future cash
flows
2. Determine the appropriate discount
rate(s)
3. Calculate the

THE ARBITRAGE-FREE
VALUATION APPROACH
The traditional approach to valuation
is to discount every cash flow of a
bond with the same discount rate (i.e.,
assuming that the yield curve is flat).
For example, consider a 10-year U.S.
Treasury note with an 6% c

Fixed Income Securities
Problem Set 1
Professor Steven V. Mann
1. Fred Derf found his lost passbook for a saving account that he had opened with a $100
deposit twelve years ago. If the bank paid interest at a rate of 5% compounded
annually over this perio