FIN 4310*02*Money and Capital Markets, Spring 2013
Prof. Ananth Narayan
HW Assignment # 2 (Chapters 6 – 9)
Instructions:
HW Assignments will be uploaded to Kean Blackboard and must be accessed from there. You must work
in groups where assigned (or independently if not assigned to groups) on homework assignments. Points
are noted against each question. You are required to submit Home Work assignments electronically on
Kean Blackboard using MS-Office or other text editor. You are required to complete your assignments as
per the due date indicated by the Professor.
Total Points in Assignment: 100
(Points scored will be scaled down to a maximum of 10 towards the final grade)
Chapter 6:
1. Commercial Paper Ratings. (5 points)
Why do ratings agencies assign ratings to commercial paper?
2. Repurchase Agreements. (5 points)
Based on what you know about repurchase agreements, would you expect them to have a lower or higher
annualized yield than commercial paper? Why?
3. Foreign Money Market Yield. (5 points)
Explain how the yield on a foreign money market security would be affected if the foreign currency
denominating that security declined to a greater degree.
4. T-bill Yield (5 points)
You paid $98,000 for a $100,000 T-bill maturing in 120 days. If you hold it until maturity, what is the Tbill yield? What is the T-bill discount?
5. Required Rate of Return. (5 points)
A money market security that has a par value of $10,000 sells for $8,816.60. Given that the security has a
maturity of two years, what is the investor’s required rate of return?
6. Effective Yield. (10 points)
A U.S. investor obtains Japanese Yen when the yen is worth 100 yen per $ and invests in a one-year
money market security that provides a yield of 5 percent (in yen). At the end of one year, the investor
converts the proceeds from the investment back to dollars at the prevailing spot rate of 90 yen per $.
Calculate the effective yield. (Hint: Calculate %∆S in dollar terms)
Chapter 7:
FIN 4310*02*Money and Capital Markets, Spring 2013
Prof. Ananth Narayan
HW Assignment # 2 (Chapters 6 – 9)
7. Call Provisions. (5 points)
Explain the use of call provisions on bonds. How can a call provision affect the price of a bond?
8. Variable-Rate Bonds. (5 points)
Are variable-rate bonds attractive to investors who expect interest rates to decrease? Explain. Would a
firm that needs to borrow funds consider issuing variable-rate bonds if it expects that interest rates
will decrease? Explain.
9. Impact of Credit Crisis on Junk Bonds. (5 points)
Explain how the credit crisis affected the default rates of junk bonds and the risk premiums offered on
newly issued junk bonds.
10. Bond Downgrade. (10 points)
Explain how the downgrading of bonds for a particular corporation affects the prices of those bonds, the
return to investors that currently hold these bonds, and the potential return to other investors who may
invest in the bonds in the near future.
Chapter 8:
11. Economic Effects on Bond Prices. (5 points)
An analyst recently suggested that there will be a major economic expansion, that will favorably affect
the prices of high-rated fixed-rate bonds, because the credit risk of bonds will decline as corporations
improve their performance. Assuming that the economic expansion occurs, do you agree with the
conclusion of the analyst? Explain.
12. Bond Price Sensitivity. (5 points)
Explain how bond prices may be affected by money supply growth, oil prices, and economic growth.
13. Interaction Between Bond and Money Markets. (10 points)
Assume that you maintain bonds and money market securities in your portfolio, and you suddenly believe
that long-term interest rates will rise substantially tomorrow (even though the market does not share
the same view), while short-term interest rates will remain the same.
a. How would you rebalance your portfolio between bonds and money market securities?
b. If the market suddenly recognizes that long-term interest rates will rise tomorrow, and that they
respond in the same manner as you, explain how the demand for these securities (bonds and
money market securities), supply of these securities for sale, and prices and yields of these
securities will be affected.
c. Assume that the yield curve is flat today. Explain how the slope of the yield curve will change
tomorrow in response to the market activity.
FIN 4310*02*Money and Capital Markets, Spring 2013
Prof. Ananth Narayan
HW Assignment # 2 (Chapters 6 – 9)
14. Bond Valuation. (10 points)
Assume the following information for an existing bond that provides annual coupon payments:
Par value = $1,000
Coupon rate = 11%
Maturity = 4 years
Required rate of return by investors = 11%
a. What is the present value of the bond?
b. If the required rate of return by investors were 9 percent, what would be the present value of the
bond?
c. What is the present value of the bond if it now becomes a zero coupon bond (does not coupon)
and the discount rate were 14 percent instead of 11 percent?
15. Bond Duration. (5 points)
A bond has a duration of 5 years and a yield to maturity of 9 percent. If the yield to maturity changes to
10 percent, what should be the percentage price change of the bond?
16. Bond Convexity. (5 points)
Describe how bond convexity affects the theoretical linear price-yield relationship of bonds. What are the
implications of bond convexity for estimating changes in bond prices?
FIN 4310*02*Money and Capital Markets, Spring 2013
Prof. Ananth Narayan
SCORING SHEET:
Chapter
6
Ques#
1
2
3
4
5
6
7
7
8
9
10
5
5
5
10
8
11
12
13
14
15
16
5
5
10
10
5
5
TOTAL
Max Points Points awarded
5
5
5
5
5
10
100
HW Assignment # 2 (Chapters 6 – 9)