FINA 4120 Exam 1 Solution

Solutions to Exam 1:

1. b Set P/Y and C/Y to 1

PV = 120,000, I/Y = 8/12, N=360
CPT PMT = $ 880.52

2. b Whenever the price of the bond increases above the call price, it will be optimal for the issuer to
call the bond.

3. b Adjust the principal at the end of each period (in this case each six months) to reflect inflation.
End of period 1: 100,000(1.015) = $101,500.00.
End of period 2: 101,500(1.015) = $103,022.50.

4. d d = (par – p)(360/T)/par = 3.59%.

5. a The relevant risk in (a) is the liquidity risk.

6. c WSJ quotes clean price. (105.219)*1000/100 = $1,052.19

7. d Note the difference between foreign bonds and Eurobonds. Yankee bonds are issued in US
dollars even though they are issued by non-American firms.

8. a Set P/Y and C/Y to 2

FV=1000, I/Y=15, N=10, PMT=50
CPT PV = -$828.40

9. b Since the bond is noncallable for the first two years, there is no prepayment risk. All the other
risks are relevant.

10. b Coupon rate is greater than the required yield for (b)

11. c First note that the coupon bonds can be replicated using zeros. Also note that the YTM on 2-year
zeros are too high, indicting under-pricing. To buy low sell high, we want to buy the replicating
portfolio of zeros and sell the coupon bonds.

12. d Fed can influence expectations and short-term rates (to some extent), but Markets determine
interest rates.

13. (a) Interest rate risk. The 30-year treasury becomes a 29-year instrument after one year and its
price depends on the interest rate one year later.

(b) Reinvestment risk. The principal of the one-year zero has to be reinvested at the end of one
year.

(c) Credit risk. Japanese government bonds have greater credit risk.
Exchange rate risk. Japanese government bonds are denominated in Yen.

14. a) Since Co-cos became equity when the issuing bank is in financial distress, the bank gets an
automatic equity boost when it is most needed.
b) Investors should be aware of the downside risk that they may not get back their principals but
the distressed bank shares instead. The high yield is to compensate for such downside risk.

FINA 4120 – Exam 1 1 practice