FINS1613 Study Guide - Quiz Guide: Accrued Interest, Clean Price, Dirty Price
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Go to the http://www.federalreserve.gov/releases/h15/data.htm to examine historical daily interest rates on U.S. Treasuries.
Scroll down to "Treasury constant maturities" and in the row "1-month" under "Nominal" click "Business day."
As you can see, rates on the one-month U.S. Treasury bill are provided for each business day from July 31, 2001 to the present. For this assignment you are asked to pick a business date five years ago this month. (For example, in January 2012 I would pick a business date in January 2007.)
Then, using this row and the subsequent rows below it under âTreasury Constant Maturitiesâ determine the shape of the yield curve (See Figure 6.11in the textbook for examples of Treasury yield curves) on that date five years ago based on the rates published by the Fed by completing the table below for the listed Treasury maturities (see example below):
Business Date Chosen Five Years Ago | 7/15/2010 |
1-month Nominal T-bill Rate on that Date | 0.16 |
3-month Nominal T-bill Rate on that Date | 0.15 |
6-month Nominal T-bill Rate on that Date | 0.2 |
1-year Nominal T-note Rate on that Date | 0.27 |
5-year Nominal T-note Rate on that Date | 1.76 |
10-year Nominal T-note Rate on that Date | 3 |
20-year Nominal T-bond Rate on that Date | 3.77 |
30-year Nominal T-bond Rate on that Date | 3.97 |
Answer the following questions:
On your selected date was the yield curve rising, falling, or flat? What explanation(s) would you give for this shape?
From my selected date, the yield curve is rising. This is due to the fact that the longer money is invested the more youâre compensated and earn due to the fact that the interest rates being higher.
Assume that two U.S. Treasury securities were purchased at par ($1000) on your selected date five years ago: 1) a 10-year T-note and 2) a 20-year T-bond. Also assume that for each of the two securities the reported nominal rate that you found above was the coupon rate at issuance.
Assuming semi-annual coupon payments, calculate the value of each bond today after 5 years based on the current 5-year Treasury constant maturity nominal rate for the original 10-year note and a current 15-year rate (assume it is the average of the current Treasury constant maturity nominal 10- and 20-year rates) for the original 20-year bond at http://www.federalreserve.gov/releases/h15/data.htm.
Complete the following tables (see example below):
10-Year Bond Purchased for $1000 5 Years Ago
Original Value | $1000 |
Coupon Rate (From table you completed above at the chosen date from 5 years ago, the original 10-year Nominal T-bond Rate divided by 2 for semi-annual payments) | |
Current 5-Year Yield to Maturity (The most recent 5-year Nominal T-note Rate reported at the Fed site divided by 2 for semi-annual payments) | |
Number of Semi-Annual Periods Remaining | |
Current Value* | |
Gain or Loss on the Bond over the 5 years |
20-Year Bond Purchased for $1000 5 Years Ago
Original Value | $1000 |
Coupon Rate (From table you completed above at the chosen date from 5 years ago, the original 20-year Nominal T-bond Rate divided by 2 for semi-annual payments) | |
Current 15-Year Yield to Maturity (Take the average of the most recent 10- and 20-year Nominal T-bond Rates reported at the Fed site, and then divide this average rate by 2 for semi-annual payments) | |
Number of Semi-Annual Periods Remaining | 30 |
Current Value* | |
Gain or Loss on the Bond over the 5 years |
*Current Value = PVBond = Coupon Payment +
b) Did you gain or lose more on one bond relative to the other? Explain.
Question 1 5 pts
0 multiple_choice_question 22046808
The internal rate of return (IRR) is the interest rate that sets the net present value of the future cash flows equal to ________.
The internal rate of return (IRR) is the interest rate that sets the net present value of the future cash flows equal to ________.
zero |
one |
one hundred |
none of the above |
Question 2 5 pts
On a timeline, the space between date 0 and date 1 represents the _______ between dates. Letâs assume it is the first year of the loan. Date 0 is the beginning of the first year, and date 1 is the end of the first year.
On a timeline, the space between date 0 and date 1 represents the _______ between dates. Letâs assume it is the first year of the loan. Date 0 is the beginning of the first year, and date 1 is the end of the first year.
dollar amount |
present value |
time period |
future value |
Question 3 5 pts
As the interest rate __________, present value decreases.
As the interest rate __________, present value decreases.
decreases |
increases |
remains unchanged |
is unrelated |
Question 4 5 pts
The present value (PV) of a stream of cash flows is the _______ the present values of each individual cash flow
The present value (PV) of a stream of cash flows is the _______ the present values of each individual cash flow
difference between |
product of |
sum of |
same as |
Question 5 5 pts
When a constant cash flow will occur at regular intervals for a finite number of periods of time, it is called a(n) __________.
When a constant cash flow will occur at regular intervals for a finite number of periods of time, it is called a(n) __________.
annuity |
perpetuity |
interest payment |
principle payment |
Question 6 5 pts
Edit this Question Delete this Question
0 multiple_choice_question 22047052
There are two basic types of annuities:
There are two basic types of annuities:
Discounted and compounded annuities |
Ordinary annuities and annuities due. |
Future value and present value annuities |
None of the above |
Question 7 5 pts
The NPV measures the ______ change in shareholder wealth that arises from undertaking a project.
The NPV measures the ______ change in shareholder wealth that arises from undertaking a project.
consistent |
dollar |
annual |
semi-annual |
Question 8 5 pts
The Net Present Value rule implies that we should compare a projectâs net present value (NPV) to ________
The Net Present Value rule implies that we should compare a projectâs net present value (NPV) to ________
zero |
one |
100 |
none of the above |
Question 9 5 pts
To endow a perpetuity is the same as calculating the present value (PV) of a perpetuity. Say you want to endow an annual graduation party at your alma mater. You want the event to be a memorable one, so you budget $30,000 per year forever for the party. If the university earns 8% per year on its investments, and if the first party is in one yearâs time, how much will you need to donate to endow the party?
The formula for PV of a perpetuity = C\r; = $30,000 \ 0.08; =
To endow a perpetuity is the same as calculating the present value (PV) of a perpetuity. Say you want to endow an annual graduation party at your alma mater. You want the event to be a memorable one, so you budget $30,000 per year forever for the party. If the university earns 8% per year on its investments, and if the first party is in one yearâs time, how much will you need to donate to endow the party?
The formula for PV of a perpetuity = C\r; = $30,000 \ 0.08; =
$3,750 |
$37,500 |
$375,000 |
$3,750,000 |
Question 10 5 pts
With an Ordinary Annuity, payments are required at the ________ of each period. An example of this is bonds which usually pay coupon payments at the end of every six months until the bond's maturity date.
With an Ordinary Annuity, payments are required at the ________ of each period. An example of this is bonds which usually pay coupon payments at the end of every six months until the bond's maturity date.
beginning |
middle |
end |
payments are not required |
Bond valuation
The process of bond valuation is based on the fundamental concept that the current price of a security can be determined by calculating the present value of the cash flows that the security will generate in the future.
There is a consistent and predictable relationship between a bondâs coupon rate, its par value, a bondholderâs required return, and the bondâs resulting intrinsic value. Trading at a discount, trading at a premium, and trading at par refer to particular relationships between a bondâs intrinsic value and its par value. These result from the relationship between a bondâs coupon rate and a bondholderâs required rate of return.
Remember, a bondâs coupon rate partially determines the interest-based return that a bond (might/will)...........pay, and a bondholderâs required return reflects the return that a bondholder(would like/is obligated).............to receive from a given investment.
The mathematics of bond valuation imply a predictable relationship between the bondâs coupon rate, the bondholderâs required return, the bondâs par value, and its intrinsic value. These relationships can be summarized as follows:
⢠| When the bondâs coupon rate is equal to the bondholderâs required return, the bondâs intrinsic value will equal its par value, and the bond will trade at par. |
⢠| When the bondâs coupon rate is greater to the bondholderâs required return, the bondâs intrinsic value will (be less than/exceed/equal)................ |
⢠| When the bondâs coupon rate is less than the bondholderâs required return, the bondâs intrinsic value will be less than its par value, and the bond will trade (at a premium/at par/at a discount)............................. |
For example, assume Liam wants to earn a return of 5.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a 8.75% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bondâs intrinsic value(Link to the formula : http://q4pws.aplia.com/q4pws/rest/1.0/image/image9594/img.png?data=q4%3AREMOTE_URL%3Ahttp%3A%2F%2Faplia-prod-webjboss-372923237.us-east-1.elb.amazonaws.com%2Fproblemsetassets%2Fq4_export%2Ffinance%2Fq4problems%2F3061500.08.xml%2CV5%2C291%2C1%2CSTUDENT%2CSTUDENT%2C0%2Cq4pws-aplia-7.6.4-G2f8d8babd91356776c6b2ec65d5e2a2153b4d346-B36-2015.12.16-03%3A57-PM-PST&oauth_signature=jG%2Fu63kSgI9xRhXign5JItWfpAQ%3D&oauth_version=1.0&oauth_nonce=3573483745&oauth_signature_method=HMAC-SHA1&oauth_consumer_key=q4-callback&oauth_timestamp=1454953012
Complete the following table by identifying the appropriate corresponding variables used in the equation.
unknown --------------------- variable name ---------------------variable value
A --------------------- (Bondholders required return/Bonds annual coupon payment/Bonds semiannual coupon payment)---------------------($21.88/$65.63/$87.50/$43.75)
B--------------------- (Bonds par value/bonds annual coupon payment/semiannual coupon payment) ---------------------$1000
C--------------------- semiannual required return -------------------- ($5.75/$3.81/$4.38/$2.5)
Based on this equation and the data, it is (reasonable/unreasonable)...................to expect that Liamâs potential bond investment is currently exhibiting an intrinsic value greater than $1,000.
Now, consider the situation in which Liam wants to earn a return of 5.75%, but the bond being considered for purchase offers a coupon rate of 8.75%. Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the bond's intrinsic value to the nearest whole dollar, then its intrinsic value of ($757/$866/$1407/$1082).................is (equal to/greater than/less than).............................its par value, so that the bond is trading at (par/a discount/a premium)..............................
Given your computation and conclusions, which of the following statements is true?
(a)When the coupon rate is greater than Liamâs required return, the bond should trade at a discount.
(b)A bond should trade at a par value when the coupon rate is greater than Liam's required return
(c) When the coupon rate is greater than Liamâs required return, the bond's intrinsic value will be less than it's par value
(d) When the coupon rate is greater than Liamâs required return, the bond should trade at a premium