Answer Happy

Question 1 (15 points). Suppose an annual coupon bond has a maturity of 7 years, a face value of $50,000, and a coupon rate of 8%. The market yield is 6% for all maturities. Part A) Calculate the market price of the bond by constructing a table just like the one in the sample spreadsheet for this question. Tips: 1) Fill in cells E2:H2 in the worksheet for the question using the information above. 2) Fill in the appropriate cells in column A with the number of the year that each payment is received 3) Fill in the necessary cells in column B with the amount of the payment received in each year, using the appropriate formula and cell references, 4) Fill in the necessary cells in column with the market price (present value) of each of the payments, using the appropriate formula and cell references. Do not use the Excel PV function for these calculations. 5) In the indicated cell in column C, calculate the price of the bond by adding up the market prices of the individual payments that you calculated in the previous step (method 1 for calculating the bond price) 6) In the indicated cell in column C, calculate the price of the bond by using the PV function in Excel and the appropriate cell references (method 2 for calculating the bond price). Part B) Use your worksheet to calculate what the price of the bond would be if the market yield fell by 0.5 percentage point. State the answer and explain in one sentence how you got it. Indicate also what percentage change in price this represents. (Hint: You don't have to do a whole new worksheet. If you have the correct formulas and cell references, you only have to change one number to get the new price.) Part C) Suppose you were given the market price of the bond instead of the yield. Explain in a few sentences how you could use your worksheet to calculate the approximate yield to maturity (YTM) of the bond by trial and error. Be as specific as possible.
Question 2 (25 points). This question is based on the example on interest risk in Slides 10-12 in Lecture 3-Part B. You have a holding period of one year and are choosing among three investment strategies: buy a 1-year zero with a face value of $10,000 and hold it to maturity, buy a 10-year zero with a face value of $15,000 and sell it at the end of the holding period, or buy a 20-year zero with a face value of $25,000 and sell it at the end of the holding period. The current interest rate is 5% for all maturities, and there are three possible scenarios for interest rates at the end of one year: they stay at 5%, they rise to 7%, or they fall to 3%. Part A) Calculate the holding period yield (HPY) for each investment strategy in each interest scenario by constructing a table just like the one in the sample spreadsheet for this question. Tips: 1) Fill in cells A4:A6 with the names of the security types. 2) Fill in cells D1, E2, G2, and 12 with the appropriate interest rate data. 3) Fill in cells B4:B6 with the face values of the three bonds and cells C4:C6 with the maturities of the three bonds. 4) Fill in the rest of the table (columns D to 1), using the appropriate formulas and cell references Part B) What conclusion can you draw from your table about the interest rate risk of the three investment strategies (the risk due to unexpected changes in future interest rates)? Be as specific as possible. Part C) Suppose your holding period was 10 years instead of one year and the three possible strategies were to buy the 1-year zero and roll it over every year till the end of the holding period, buy the 10-year bond and hold it to maturity, or buy the 20-year bond and sell it at the end of the holding period. How do you think the interest rate risk of these strategies would compare? Explain. (Do not do any calculations. Just try to reason it out.)