Abigail Neri

Module 6 Assignment

106 -

6 Nominal and Real Rates and Yield curves

US
Treasury security

#
G. r
,
=
r t IP t RP
;
RP =
O
*
r = r
,
-
IP

us treasury Nominal Real Rate

(r ) ( rt )
security of interest
=
rate IP
-

A 12 -

6% -

9.5% =
3.1%
B ll 2 8-2 =
3.0
-
'

C 13 O 10.0 3.
-
- =
O

D II. O 8. I 2. g
-

E 11.4
-

8-3 =
3.1

b .

As for the behavior of the Real rate

of interest over the

year ,
it can be seen that the real rate of interest from
January to March decreased by O I
-

% while at the

months March it stable

course of from to
May was

3.0% %
at A
slight decrease of O I again for the months
-

between May to August and it finally ,

increased by 0.240
in December .
The forces that might be responsible for
of interest
such behavior on the real rate are the

changing economic conditions ,

in relation to the US

Treasury securities ,
such as the deficit in the federal
government budget and international trade balance
C- Yield curve
of us Tresury securities
15 -

••-_
•

12
°
ooo

q
-

6 -

I
3

- l l l l l
' ' ' '
o 5 10 15 20 25

d .

The yield curve shown above depicts a downward

sloping behavior and it indicates that the short -

term interest rates are

generally higher than the

long -
term interest rates .

Since the
yield curve is downward sloping financial
managers may be tempted to rely more heavily on

cheaper , long-term financing .

PG -

7 Risk premiums
Eleanor Burns

A- Rp =
r* t Ip

Security A :
Security B :

Rp =
20/0 t
990 Rf =
2% t
7%
=
110/0 =
q Yo
I
=

b .
Rp -

liquidity risk t
Default risk t
Maturity risk t other risk

Security A :
Security B :

RP = 1% t Iyo t O' 5- Yo to -5% RP = 10/0 t 2% t 1540 t 1.5%

=
30/0 =
640
I =

C .
r, =
Re t RP ,

security A security B :

r, = 11 Yo t 3 Yo r
,
=
940 t 6%
=
14% =
15%
= =

The computations above show that Security A resulted to

a
higher risk free rate of interest compared to
-

Security B and it as well presented a lower risk

premium ,
due to its higher expectation premium .
The results

indicate that security A has a

bearing of being less risky
than the other one but it is also expected that it will yield
a lower return rate .
PG -

la Bond value and Time :

changing Required Returns

Lynn Parsons

a . Bond A

t .

8%
PV
of Principal
=
$1000 ÷ 1.085
=
680.58

PV of Interest
=
( ( $1000 x Holo ) ÷ 0.08 ) x ( I fi :-( 1.085 )))
-

=
1375 X O .
319416803
=
439.20

Bond Price PV
of principal PV interest
=
t
of
=
680 -

58 t
43920
=
$1119.78
-

2- 11%
PV
of Principal
=
$1000 ÷ i. 115
=
593 .
45

PV of Interest
=
( ( $1000 x Holo ) ÷ 0.11 ) x ( I ( I :-(
-

i. )
115 ))
=
1000 X O '

4065486719
=
406.55

Bond Price PV
of principal PV interest
=
t
of
=
593 .
45 t 406 '
55
=
4*0
-
 3. 14%
PV
of Principal
=
$1000 ÷ i. 145
=
519.37

PV of Interest
=
( ( $1000 xll% ) ÷ 0.14 ) x ( I fi :-( 1.145 )))
-

=
785.7142857 ×
0.4806313356
=
377.64

Bond Price PV
of principal PV Interest
=
t
of
=
519.37 t 377.64
=
1*97-01
-

b -
Bond B

l -

8%
PV
of Principal
=
$1000 ÷ i. 0815
=
315.24

PV of Interest
=
( ( $1000 x 11%1 ÷ 0.08 ) x ( I ( I :-(
-

I )
-0815 ))
=
1375 x O -

684758295
=
941 .
54

Price
Bond PV
of principal PV Interest
=
t
of
=
315.24 t 941 .
54
=
1512¥78
-
2 .
11%
PV
of Principal
=
$1000 ÷ i. 1115
=
209 OO-

PV of Interest
=
( ( $1000 xlilo.o.lt ) x ( I fi :-( 1.1115 )))
-

=
1000 x O -

7909956533
=
791

Price
Bond PV
of principal PV Interest
=
t
of
=
209 t 791
=
4*0
-

z .
1490
PV
of Principal
=
$1000 ÷ i. 1415
=
140.10

PV of Interest
=
( ( $1000 xll% ) ÷ 0.14 ) x ( I fi :-( 1.1415 )))
-

=
785.7142857 X
O .

8599035179
=
675.64

Price
Bond PV
of principal PV Interest
=
t
of
=
140 -

IO t 675 -

64
=
481¥74
-
C- Required Return Value of Bond A Value of Bond B

8% $ 1119 78-

$ 1256-78

110/0 1000 -

OO 1000 -

OO

140/0 897 -

01 815 .

73

It observed that the the length of

can be longer
maturity ,
the higher the bond price . On the

other hand ,
the higher the
required return
rate ,
the lower the bond price .
However ,
if the

required return rate is

equal to the coupon interest
rate then the bond value is the same to its par value .

d .

If Lynn wanted to minimize interest rate risk ,

she should purchase Bond A where it has the

shorter time of maturity compared to Bond B -

It is also evident that as the return rate increases

over time , the shorter the
maturity time will
incur minimal impact for Bond A compared to

Bond B ,
hence the better option for Lynn Parsons .