Can you help me to answer these two advanced questions?

Can you help me to answer these two advanced questions?

admin / August 17, 2018

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Money & Banking Practice problems 1 1. Consider the following 4 bonds, each with a face value of F = $10, 000, currently being sold in the…

Can you help me to answer these two advanced questions?

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Money & Banking
Practice problems 1
1. Consider the following 4 bonds, each with a face value of
F
= $10
,
000,
currently being sold in the primary market:
A
: a 2 year coupon bond with a coupon rate of
c
A
= 5 percent and priced
at
P
A
(
t
) = $10
,
000.
B
: a 2-year discount bond, priced at
P
B
(
t
) = $9
,
070
.
29.
C
: a 30-year discount bond, priced at
P
C
(
t
) = $2
,
313
.
77.
D
: a console with an annual coupon payment of $500 and priced at
P
D
(
t
) = $10
,
000.
(a) Calculate the yield to maturity on each bond,
i
j
,
j
=
A,B,C,D
.
(b) Suppose that market conditions remain unchanged over the next
year, so that interest rates remain where they were when the bonds
were initially sold in the primary market. First, calculate the max-
imum value that others would be willing to pay for each bond in
the secondary market,
P
j
(
t
+ 1),
j
=
A,B,C,D.
Second, calculate
the one-year rate of return,
ret
j
, for each bond, assuming that it is
sold at that maximum price,
P
j
(
t
+ 1).
(c) Suppose alternatively that after one year, all market interest rates
increase by 5 percentage points. Redo the calculations in (b), for
each of the 4 bonds.
(d) Now consider a 5th bond (
E
). It is identical to bond
A
in terms of
the following payout features:
F
E
= $10
,
000,
n
E
= 2, and
c
E
= 5
percent. However, it is sold in the primary market in
t
+ 1 under
the tighter market conditions specified in (c). Without calculating
P
E
(
t
+ 1), prove that, under these tighter market conditions, bond
E
would sell in the primary market at a lower price than did bond
A
,
P
E
(
t
+ 1)
< P A ( t ). You should also be able to verify that, if these tighter market conditions were to persist into the next year, the price of this bond would rise (i.e., P E ( t +2) > P
E
(
t
+1)). [Again
it is not necessary to do any numerical calculations.]
2. You are offered a one-year subscription to the
Economist
for $55, or a
two-year subscription for $105. Assume that you plan to get the periodi-
cal for at least the next two years. (a) If the current market interest rate
is 5 percent, would you subscribe today for one or two years? (b) What
is highest market interest rate which makes the two-year subscription a
better deal? (c) Would your answer to part b necessarily change, if you
were to expect inflation over the next year?

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