FINA 475 Lecture Notes - Lecture 11: Yield Curve, Bond Duration

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ambermuskrat630

27 Nov 2017

School

USC, SC, Carolina, South Carolina

Department

Finance

Course

FINA 475

Professor

Putnam

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Document Summary

Bullet strategy: maturities are highly concentrated at one point on the yield curve ie: 10% of bonds are 5 year in maturity, 80% is 10 year, and 10% is 20 year. Barbell strategy: maturities are concentrated at the two extremes ie: 40% at 5 year, 20% at 10 year, and 40% at 20 year. Ladder strategy: equal amounts of each maturity ie: 33% 5 year, 34% 10 year, and 33% at 20 year. If bond duration is 4 years, and the yield changes by 100 basis points, bond value changes by 4% If the portfolio duration is 4 years, and the yield changes by 100 basis points: With a parallel shift of the yield curve, portfolio value will change by 4% Strategy identifies an issue that is undervalued because: Yield is expected to decline and price will therefore rise because credit analysis indicates that rating will improve.

Related Questions

Please can someone help me with this :

Minicase 1

Interest Rates, Bond Yields, and Duration

CONCEPTS IN THIS CASE

simple loans
fixed-payment loans
coupon bonds
present value
yield-to-maturity
current yield
nominal and real interest rates
rate of return
capital gain
interest-rate and reinvestment risk
duration

You have been hired to analyze the debt securities of your organization. The firm has outstanding loans and bonds. A quick review of the balance sheet shows the following:

	Liability Amount ($)	Nominal Interest (coupon) Rate	Years to Maturity
Selected Liabilities of the firm
Simple Loans	800	5%	1
Fixed-Payment Loans	5,000	12%	19
Long-term Bonds #1	500,000	10%	4
Long-term Bonds #2	1,080,000	10%	10
Liabilities Total	1,585,800

Market Price for Bond #1	930.50
Market Price for Bond #2	859.50
Face Value of Each Bond	1,000.00
Selected Current Assets of the firm
Marketable Securities:
Treasury Bills	100,000

Note: Treasury Bills have a $10,000 face value, which matures in one year. Each Treasury Bill has a cost of $9,580.00

How much interest would the firm pay each year on the simple-interest loan?

How much would you write a cheque for to pay off the loan in one year?

What is the monthly payment needed to pay off the fixed-payment loans?

What is the current yield for each bond if the current price is:

$930.50 for Bond #1?

$859.50 for Bond #2?

What is the expected yield to maturity for each bond?

Bond #1 selling for $930.50?

Bond #2 selling for $859.50

What is the rate of capital gain if both bonds sell for $900.00 in one year?

Bond #1 selling for $930.50 today?

Bond #2 selling for $859.50 today?

If the Yield to Maturity expected by investors changes to 11%:

What will be the market price of Bond #1?

What will be the market price for Bond #2?

What will be the dollar change in price for Bond #1?

What will be the dollar change in price for Bond #2?

What will be the percent change in price for Bond #1?

What will be the percent change in price for Bond #2?

Since the change in expected yield to maturity is the same, why is the amount of change different between the bonds?

If investors holding our 4-year bonds (Bond #1) receive interest income annually for four years, plus the face value of the bonds at maturity,

What will be the total interest earned on the bond over the next four years?

What will be the face value received at maturity?

Given the following projected income stream for Bond #1:

			Projected Reinvestment Rates
Year	Coupon Interest ($)	Face Value ($)	10%	5%
1	100
2	100		10.00	5.00
3	100		21.00	10.25
4	100	1000	33.10	15.76
Total Income	400	1000	64.10	31.01

What is the total cash available over the next four years to the bond holder earning

10%

15%

What is the average annual rate of return for the bond holder earning

10%

15%

Why does the reinvestment rate affect the annual rate of return for the same bond?

If the expected rate of return on our bonds is 10%, what is the duration of Bond #1?

What is the yield to maturity on the Treasury Bills (a discount bond)?

What is the real rate of interest if the nominal rate is 10% and the inflation rate is 3%?

amethystcrow453

You have been hired to analyze the debt securities of your organization. The firm has outstanding loans and bonds. A quick review of the balance sheet shows the following:

	Liability Amount ($)	Nominal Interest (coupon) Rate	Years to Maturity
Selected Liabilities of the firm
Simple Loans	800	5%	1
Fixed-Payment Loans	5,000	12%	19
Long-term Bonds #1	500,000	10%	4
Long-term Bonds #2	1,080,000	10%	10
Liabilities Total	1,585,800

Market Price for Bond #1	930.50
Market Price for Bond #2	859.50
Face Value of Each Bond	1,000.00
Selected Current Assets of the firm
Marketable Securities:
Treasury Bills	100,000

Note: Treasury Bills have a $10,000 face value, which matures in one year. Each Treasury Bill has a cost of $9,580.00

1-How much interest would the firm pay each year on the simple-interest loan?

2-How much would you write a cheque for to pay off the loan in one year?

3-What is the monthly payment needed to pay off the fixed-payment loans?

4-What is the current yield for each bond if the current price is:

a-$930.50 for Bond #1?

b-$859.50 for Bond #2?

5-What is the expected yield to maturity for each bond?

a-Bond #1 selling for $930.50?

b-Bond #2 selling for $859.50

6-What is the rate of capital gain if both bonds sell for $900.00 in one year?

a-Bond #1 selling for $930.50 today?

b-Bond #2 selling for $859.50 today?

7-If the Yield to Maturity expected by investors changes to 11%:

a-What will be the market price of Bond #1?

b-What will be the market price for Bond #2?

c-What will be the dollar change in price for Bond #1?

d-What will be the dollar change in price for Bond #2?

e-What will be the percent change in price for Bond #1?

f-What will be the percent change in price for Bond #2?

g-Since the change in expected yield to maturity is the same, why is the amount of change different between the bonds?

8-If investors holding our 4-year bonds (Bond #1) receive interest income annually for four years, plus the face value of the bonds at maturity,

a-What will be the total interest earned on the bond over the next four years?

b-What will be the face value received at maturity?

Given the following projected income stream for Bond #1:

			Projected Reinvestment Rates
Year	Coupon Interest ($)	Face Value ($)	10%	5%
1	100
2	100		10.00	5.00
3	100		21.00	10.25
4	100	1000	33.10	15.76
Total Income	400	1000	64.10	31.01

c-What is the total cash available over the next four years to the bond holder earning

ii-10%

iii-15%

d-What is the average annual rate of return for the bond holder earning

ii-10%

iii-15%

e-Why does the reinvestment rate affect the annual rate of return for the same bond?

f-If the expected rate of return on our bonds is 10%, what is the duration of Bond #1?

raspberryalligator692

Please answer all of the following questions

1) The CAPM implies that:

a. investors may invest in assets with expected returns lower than the riskless interest rate.

b. no investor should invest in the risk-free asset.

c. the only relevant measure of risk is standard deviation.

d. the expected return on an efficient portfolio may be lower than the riskless interest rate.

2) In case of a simple CAPM being used to estimate a time series data:

a. the mean of a residual risk should be equal to zero.

b. the regression coefficient should be equal to zero.

c. the difference between the market return and the riskfree rate of return should be equal to zero.

d. the beta of the portfolio should be equal to zero.

3)Which of the following statements is true?

a. An increase in coupons increases the duration of the bond.

b. The longer the maturity of a bond, the greater will be its duration.

c. An increase in the interest rate decreases the duration of the bond.

d. Duration is a measure of the sensitivity of the equities.

4) Which of the following investment strategies is inconsistent with a "contrarian" philosophy

a. buying low, selling high

b. buying when odd-lot buying is lower than normal

c. buying when mutual fund cash positions are low

d. buying when most investment advisory services are bearish

e. selling after a market crash or decline

5) All other things equal, which of the following bond price is more sensitive to interest rate changes?

a. a 10 year bond with a 10% coupon

b. a 20 year bond with a 7% coupon

c. a 20 year bond with a 10% coupon

d. a 30 year bond with 7% coupon

6) Studies of firms classified on the basis of P/E ratios come to the conclusion that low-P/E-ratio stocks earn much higher returns, after adjusting for risk, than high-P/E-ratio stocks. This is because

a. low-P/E-ratio stocks are riskier than high-P/E-ratio stocks.

b. investors like low-P/E-ratio stocks.

c. low-P/E-ratio stocks are more likely to be undervalued.

7) Tests of market efficiency tend to

a. look for statistical dependencies that exist in price changes over time.

b. measure the nature of the impact of new information on security prices as that new information becomes available.

c. search for trading systems that might be able to generate supernormal profits.

d. all of the above

FINA 475 Lecture Notes - Lecture 11: Yield Curve, Bond Duration

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