cityboy

6. The yield of a 3-year bond issue quoted on an annual-pay basis is 7.84%. The yield-to-maturity on a bond-equivalent basis is closest to: A. 3.85% B. 7.69% C. 7.84%

Ans: B; (1+bond-equivalent yield/2) 2 =1+annual-pay yield In this case, (1+bond-equivalent yield/2) 2 =1+0.0784 Therefore, bond-equivalent yield=7.69% B is the correct answer.

cityboy

5. Elaine Wong has purchased an 8% coupon bond for $1,034.88 with 3 years to maturity. At what rate must the coupon payments be reinvested to produce a 5% yield-to-maturity rate? A. 8% B. 6.5% C. 5%

Ans: C; C is correct. Yield-to-maturity measure assumes that the coupon payments can be reinvested at the yield-to-maturity. In this case, it’s 5%. C is the correct answer.

cityboy

4. Using the BEY (bond-equivalent yield) spot rates for U.S. Treasury yields provided in the following table, the 6-month forward rate one year from now on a bond-equivalent yield basis is closest to: Period Years Spot Rate 1 0.5 1.40% 2 1.0 2.30 % 3 1.5 3.00% 4 2.0 3.50% A. 4.41% B. 2.20% C. 2.30%

Ans: A; Assume: xfy represents x-period forward rate y-period from now; Z x+y represents (x+y)-period spot rate; Z y represents y-period spot rate. We have (1+Z x+y)x+y=(1+Zy)y (1+xfy)x 6-month forward rate one year from now in this case is 1 period forward rate 2-period from now. All spot rates are given on a BEY basis and must be divided by 2 in the calculation: (1+1f 2)1 (1+0.023/2)2=(1+0.03/2)3 1f 2=0.022038 On a BEY basis, the forward rate is 0.022038*2=4.41%

cityboy

3. Using the U.S. Treasury forward provided in the following table, the value of a 2 year, 100 par value Treasury bond with a 4% coupon rate is closes to: Period Years Forward Rate 1 0.5 1.1% 2 1.0 1.7% 3 1.5 2.2% 4 2.0 2.5% A. $104.20 B. $100 C. $98.74

Ans: A; According to the definition of the forward rate, the value of the bond= +++ =$104.20

cityboy

2. Consider the three bonds in the following table. Which of the three bonds is most likely to have the greatest reinvestment risk? Bond YTM Time to Maturity Current Price A 8% 15 $980 B 8% 15 $1,000 C 8% 15 $1,098 A. Bond A B. Bond B C. Bond C

Ans: C; The yield to maturity assumes the coupon payments are reinvested at the yield to maturity and the bond will be held until maturity. The bond selling at a premium has the highest coupon rate and thus is expected to earn the most reinvestment income. If the reinvestment rate falls, this bond will suffer the greatest loss. Therefore Bond C, which is currently selling at premium, is most likely to have the greatest reinvestment risk.