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Self Study Questions TOPIC 3 VALUATION PART 1 - BONDS Question 1 A debt security has four years to maturity, pays

$1000 in annual interest and has a face value of $10,000. The required rates of return are 4% for the first year, 6% for the second year, 3% for the third year and 5% for the fourth year. What is the present value of the security? a) b) c) d) $11,975.62 $10,675 $10,000 $7,577

Question 2 A $1000 bond has a 12 percent coupon rate and pays interest semi-annually. If there are five years left to maturity, and if the current market yield is 10 percent, what is the bond worth today? a) $ 463.30 b) $ 752.45 c) $1,000.00 d) $1,077.21 Question 3 Using semi-annual compounding, a 15 year zero coupon bond that has a face value of $1,000 and a required return of 8% p.a. would be priced at: a) $308 b) $315 c) $464 d) $555 Question 4 You buy a two year bond which pays interest of 12% p.a. At the end of year two, you purchase a one year bond that pays interest of 10% p.a. According to the expectations theory of interest rates, you could have purchased a three year bond today that paid interest each year of: a) 11.0% b) 11.3% c) 11.5% d) cannot be determined

Question 5 One-year interest rates are 6 percent. The market expects one-year rates to be 7 percent one year from now. The market also expects one-year rates will be 8 percent two years from now. Assume that the pure expectations theory holds regarding the term structure. Which of the following statements is most correct? a) The yield curve is downward sloping. b) Todays two-year interest rate is 8 percent. c) Todays two-year interest rate is 7 percent. d) Todays three-year interest rate is 7 percent. Question 6 Which of the following statements is most correct?

a) All else equal, if a bonds yield to maturity increases, its current yield will fall. b) All else equal, if a bonds yield to maturity increases, its price will fall. c) If a bonds yield to maturity exceeds the coupon rate, the bond will sell at a
premium.

d) All of the answers above are correct.


Question 7 You are examining two bonds, each with a par value of $1,000, as potential investments. They are: (i) Bond A: A bond with seven years to maturity that pays 10 percent per annum compounded semi-annually. The current market yield for this bond is 7 percent compounded semi-annually and the current market price of the bond is $750.00 Bond B: A bond with ten years left to maturity that pays 12 percent per annum compounded semi-annually. The current market yield for this bond is 10 percent compounded semi-annually and the current market price of the bond is $400.00

(ii)

Which bond(s) should you invest in? Explain your answer fully. Question 8 Two years ago, you bought a government bond for $1000 on issue because you liked the 10% coupon interest that you would receive for 10 years. Interest on the bond is paid annually. Two years later, when the market interest rate has fallen to 8%, what is the value of your bond?