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Homework 5
Due 10/10/2014
1. Suppose you purchase a 30-year, zero-coupon bond with a yield to maturity of 6%.
You hold the bond for five years before selling it.
(a) If the bonds yield to maturity is 6% when you sell it, what is the internal rate of
return of your investment?
(b) If the bonds yield to maturity is 7% when you sell it, what is the internal rate of
return of your investment?
(c) If the bonds yield to maturity is 5% when you sell it, what is the internal rate of
return of your investment?
(d) Even if a bond has no chance of default, is your investment risk free if you plan
to sell it before it matures? Explain.
Pnew
Porig
1/t
(a) If the bonds coupon rate c is larger than its yield to maturity y, then the bonds
price is larger than its face value FV.
(b) If the bonds price is larger than its face value FV, then the bonds coupon rate
c is larger than its yield to maturity y.
Note: This problem presents a quick way check as to whether a bond is being sold at
a premium, discount, or at par.
5. Please indicate whether each of the following statements is true or false. If it is true,
explain/prove why it is true. If it is false, explain why or provide a counterexample.
Credit will not be given unless an explanation is provided.
(a) Given an APR of 12% compounded semiannually, the effective monthly rate is
1%.
(b) Bond A is a 10-year, semi-annual coupon bond with face value $1000 and coupon
payment of $50. Bond B is a 20-year, annual coupon bond with face value $4000
and coupon payment of $200. Given the yield to maturity of both bonds are the
same, and are 15%, the true price of bond A is less than the true price of
bond B.
(c) An n-year, annual-coupon bond with coupon rate 10% is priced at half of its face
value. In order for this bond to have a yield to maturity of 8%, n must be at least
30.
(d) Suppose you have two cash flows (0,2,2,2,...) and (0,1,3,1,3,...), then for any
interest rate the PV of the first cash flow is greater than or equal to the PV of
the second cash flow.
(e) Your little sister proposes the following game to you. On day 1, you will give her
$1. On day 2, she will give you $2. And in general, you will give her $i on day i if
i is odd, and she will give you $i on day i if i is even (so that the cash flow from
your point of view is (0,-1,2,-3,4,-5,6,...)). Living in a hypothetical world where
interest rate per day is 10%, should you take up her offer?