Currently, the term structure is as follows: One-year bonds yield 7%, two-year bonds yield 8%, three-year bonds and greater maturity bonds all yield 9%. You are choosing between one-, two-, and three-year maturity bonds all paying annual coupons of 8%, once a year. Which bond should you buy if you strongly believe that at year-end the yield curve will be flat at 9%?
Three year maturity bond
From the table above, it is apparent that the three year bond would give 9% holding period return which is the highest amongst all. Hence one should buy this.
Return to Table 10.1 and calculate both the real and nominal rates of return on the TIPS bond in the second and third years.
Inflation in Year just ended
Coupon Payment + Principal payment
$ 1000 .00
$ 1050. 60
On May 30, 2009, Janice Kerr is considering the newly issued 10-year AAA corporate bonds shown in the following exhibit:
Sentinal due, May 30, 2019
Collina due, May 30, 2019
a. Suppose that market interest rates decline by 100 basis points (i.e., 1%). Contrast the effect of this decline on the price of each bond.
b. Should Kerr prefer the Colina over the Sentinal bond when rates are expected to rise or to fall?
c. What would be the effect, if any, of an increase in the volatility of interest rates on the prices of each bond?
Question: A 30-year maturity, 8% coupon bond paying coupons semi-annually is callable in five years at a call price of $1,100. The bond currently sells at a yield to maturity of 7% (3.5% per half-year):
a. What is the yield to call?
b. What is the yield to call if the call price is only $1,050?
c. What is the yield to call if the call price is $1,100 but the bond can be called in two years instead of five years?
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