Question: Under the liquidity preference theory, if inflation is expected to be falling over the next few years, long-term interest rates will be higher than short-term rates. True/false/ uncertain? Why?
As per the liquidity preference theory, a higher rate of interest on securities should be demanded by an investor on long term maturities.
If the liquidity premium is great, long-term yields can even exceed short-term yields despite having expectations of falling short rates. Thus, the interest rates in the long-term will be higher than in the short run.
Question: Masters Corp. issues two bonds with 20-year maturities. Both bonds are callable at $1,050. The first bond is issued at a deep discount with a coupon rate of 4% and a price of $580 to yield 8.4%. The second bond is issued at par value with a coupon rate of 8.75%.
a. What is the yield to maturity of the par bond? Why is it higher than the yield of the discount bond?
b. If you expect rates to fall substantially in the next two years, which bond would you prefer to hold?
c. In what sense does the discount bond offer “implicit call protection”?
Philip Morris has issued bonds that pay annually with the following characteristics:
Yield to Maturity
a. Calculate modified duration using the information above.
b. Explain why the modified duration is a better measure than maturity when calculating the bond’s sensitivity to changes in interest rates.
c. Identify the direction of change in modified duration if:
i. The coupon of the bond was 4%, not 8%.
ii. The maturity of the bond was 7 years, not 15 years.
A 30-year maturity bond making annual coupon payments with a coupon rate of 12% has duration of 11.54 years and convexity of 192.4. The bond currently sells at a yield to maturity of 8%. Use a financial calculator or spreadsheet to find the price of the bond if its yield to maturity falls to 7% or rises to 9%. What prices for the bond at these new yields would be predicted by the duration rule and the duration-with-convexity rule?
What is the percent error for each rule? What do you conclude about the accuracy of the two rules?
94% of StudySmarter users get better grades.Sign up for free