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SolutionVManualBondVMarketsVAnalysisVandVStrategiesV8thVGlobal
_Edition
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CHAPTER 1 V
(QuestionsVareVinVboldVprintVfollowedVbyVanswers.)
WhatVisVtheVcashVflowVofVaV8-
yearVbondVthatVpaysVcouponVinterestVsemiannually,VhasVaVcouponVrateVofV6%,Va
ndVhasVaVparVvalueVofV$100,000?
TheVprincipalVorVparVvalueVofVaVbondVisVtheVamountVthatVtheVissuerVagreesVtoVrepayVth
eVbondholderVatVtheVmaturityVdate.VTheVcouponVrateVmultipliedVbyVtheVprincipalVofVthe
VbondVprovidesVtheVdollarVamountVofVtheVcouponV(orVannualVamountVofVtheVinterestVpa
yment).VAnV8-
VyearVbondVwithVaV6%VannualVcouponVrateVandVaVprincipalVofV$100,000VwillVpayVsemian
nualVinterestVofV(0.06/2)($100,000)V=V$3,000VforV8(2)V=V16Vperiods.VThus,VtheVcashVflow
VisV$3,000.VInVadditionVtoVthisVperiodicVcash,VtheVissuerVofVtheVbondVisVobligatedVtoVpay
VbackVtheVprincipalVof
$100,000VatVtheVtimeVtheVlastV$3,000VisVpaid.
WhatVisVtheVcashVflowVofVaV4-
yearVbondVthatVpaysVnoVcouponVinterestVandVhasVaVparVvalueVof
$1,000?
ThereVisVnoVperiodicVcashVflowVasVfoundVinVtheVpreviousVproblem.VThus,VtheVonlyVcashVfl
owVwillVbeVtheVprincipalVpaymentVofV$1,000VreceivedVatVtheVendVofVsixVyears.VThisVtypeV
ofVcashVflowVresemblesVaVzero-
couponVbond.VTheVholderVofVsuchVaVbondVrealizesVinterestVbyVbuyingVtheVbondVsubstantia
llyVbelowVitsVprincipalVvalue.VInterestVisVthenVpaidVatVtheVmaturityVdate,VwithVtheVexactVa
mountVbeingVtheVdifferenceVbetweenVtheVprincipalVvalueVandVtheVpriceVpaidVforVtheVbon
d.
GiveVthreeVreasonsVwhyVtheVmaturityVofVaVbondVisVimportant.
ThereVareVthreeVreasonsVwhyVtheVmaturityVofVaVbondVisVimportant.VFirst,VtheVmaturityVgi
vesVtheVtimeVperiodVoverVwhichVtheVholderVofVtheVbondVcanVexpectVtoVreceiveVtheVcoup
on payments and the number of years before the principal will be paid in full. Second,
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marketVchange.VTheVvolatilityVofVaVbond’sVpriceVisVdependentVonVitsVmaturity.VMoreVspeci
fically,VwithVallVotherVfactorsVconstant,VtheVlongerVtheVmaturityVofVaVbond,VtheVgreaterVth
eVpriceVvolatilityVresultingVfromVaVchangeVinVmarketVyields.
ExplainVwhetherVorVnotVanVinvestorVcanVdetermineVtodayVwhatVtheVcashVflowVofVaVfl
oating-rateVbondVwillVbe.
Floating-
rateVbondsVareVissuesVwhereVtheVcouponVrateVresetsVperiodicallyVbasedVonVaVgeneralVfor
mulaVequalVtoVtheVreferenceVrateVplusVtheVquotedVmargin.VTheVreferenceVrateVisVsomeVi
ndexVsubjectVtoVchange.VTheVexactVchangeVisVunknownVandVuncertain.VThus,VanVinvestorV
cannotVdetermineVtodayVwhatVtheVcashVflowVofVaVfloating-
rateVbondVwillVbeVinVtheVfuture.
SupposeVthatVcouponVresetVformulaVforVaVfloating-rateVbondVis:V1-
monthVLIBORV+V130VbasisVpoints.
WhatVisVtheVreferenceVrate?
TheVreferenceVrateVisVtheV1-monthVLIBOR.
WhatVisVtheVquotedVmargin?
TheVquotedVmarginVisVtheV130VbasisVpointsV(orV1.30%).
SupposeVthatVonVcouponVresetVdateVthatV1-
monthVLIBORVisV2.4%.VWhatVwillVtheVcouponVrateVbeVforVtheVperiod?
TheVcouponVresetVformulaVis:V1-monthVLIBORV+V130VbasisVpoints.VSo,VifV1-
monthVLIBORVonVtheVcouponVresetVdateVisV2.4%,VtheVcouponVrateVisVresetVforVthatVperio
dVatV2.40%V+V1.30%V=V3.70%..
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WhatVisVaVdeferredVcouponVbond?
Deferred-
couponVbondsVareVcouponVbondsVthatVletVtheVissuerVavoidVusingVcashVtoVmakeVinterestVp
aymentsVforVaVspecifiedVnumberVofVyears.VThereVareVthreeVtypesVofVdeferred-
couponVstructures:
(1)Vdeferred-interestVbonds,V(2)Vstep-upVbonds,VandV(3)Vpayment-in-kindVbonds.
WhatVisVmeantVbyVaVlinker?
AVlinkerVisVaVbondVwhoseVinterestVrateVisVtiedVtoVtheVrateVofVinflation.VTheVU.S.VTreasuryVis
suesVlinkers,VandVtheyVareVreferredVtoVasVTreasuryVInflationVProtectionVSecuritiesV(TIPS).
AnswerVtheVbelowVquestions.
WhatVisVmeantVbyVanVamortizingVsecurity?
TheVprincipalVrepaymentVofVaVbondVissueVcanVbeVforVeitherVtheVtotalVprincipalVtoVbeVrep
aidVatVmaturityVorVforVtheVprincipalVtoVbeVrepaidVoverVtheVlifeVofVtheVbond.VInVtheVlatter
Vcase,VthereVisVaVscheduleVofVprincipalVrepayments.VThisVscheduleVisVcalledVanVamortizatio
nVschedule.VLoansVthatVhaveVthisVamortizingVfeatureVareVautomobileVloansVandVhomeVmort
gageVloans.VThereVareVsecuritiesVthatVareVcreatedVfromVloansVthatVhaveVanVamortizationVs
chedule.VTheseVsecuritiesVwillVthenVhaveVaVscheduleVofVperiodicVprincipalVrepayments.VSuc
hVsecuritiesVareVreferredVtoVasVamortizingVsecurities.
WhyVisVtheVmaturityVofVanVamortizingVsecurityVnotVaVusefulVmeasure?
ForVamortizingVsecurities,VinvestorsVdoVnotVtalkVinVtermsVofVaVbond’sVmaturity.VThisVisVbe
causeVtheVstatedVmaturityVofVsuchVbondsVorVsecuritiesVonlyVidentifiesVwhenVtheVfinalVprin
cipalVpaymentVwillVbeVmade.VForVanVamortizedVsecurity,VtheVrepaymentVofVtheVprincipalVi
sVmadeVthroughVmultipleVpaymentsVoverVitsVmaturityVandVnotVjustVatVtheVendVofVitsVter
mVtoVmaturity.VThus,VtheVmaturityVisVnotVaVusefulVmeasureVinVtermsVofVidentifyingVwhen
VtheVprincipalVisVrepaid.
V|VPVaVg
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SolutionVManualBondVMarketsVAnalysisVandVStrategiesV8thVGlobal
_Edition
,2
V|VPVaVg
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CHAPTER 1 V
(QuestionsVareVinVboldVprintVfollowedVbyVanswers.)
WhatVisVtheVcashVflowVofVaV8-
yearVbondVthatVpaysVcouponVinterestVsemiannually,VhasVaVcouponVrateVofV6%,Va
ndVhasVaVparVvalueVofV$100,000?
TheVprincipalVorVparVvalueVofVaVbondVisVtheVamountVthatVtheVissuerVagreesVtoVrepayVth
eVbondholderVatVtheVmaturityVdate.VTheVcouponVrateVmultipliedVbyVtheVprincipalVofVthe
VbondVprovidesVtheVdollarVamountVofVtheVcouponV(orVannualVamountVofVtheVinterestVpa
yment).VAnV8-
VyearVbondVwithVaV6%VannualVcouponVrateVandVaVprincipalVofV$100,000VwillVpayVsemian
nualVinterestVofV(0.06/2)($100,000)V=V$3,000VforV8(2)V=V16Vperiods.VThus,VtheVcashVflow
VisV$3,000.VInVadditionVtoVthisVperiodicVcash,VtheVissuerVofVtheVbondVisVobligatedVtoVpay
VbackVtheVprincipalVof
$100,000VatVtheVtimeVtheVlastV$3,000VisVpaid.
WhatVisVtheVcashVflowVofVaV4-
yearVbondVthatVpaysVnoVcouponVinterestVandVhasVaVparVvalueVof
$1,000?
ThereVisVnoVperiodicVcashVflowVasVfoundVinVtheVpreviousVproblem.VThus,VtheVonlyVcashVfl
owVwillVbeVtheVprincipalVpaymentVofV$1,000VreceivedVatVtheVendVofVsixVyears.VThisVtypeV
ofVcashVflowVresemblesVaVzero-
couponVbond.VTheVholderVofVsuchVaVbondVrealizesVinterestVbyVbuyingVtheVbondVsubstantia
llyVbelowVitsVprincipalVvalue.VInterestVisVthenVpaidVatVtheVmaturityVdate,VwithVtheVexactVa
mountVbeingVtheVdifferenceVbetweenVtheVprincipalVvalueVandVtheVpriceVpaidVforVtheVbon
d.
GiveVthreeVreasonsVwhyVtheVmaturityVofVaVbondVisVimportant.
ThereVareVthreeVreasonsVwhyVtheVmaturityVofVaVbondVisVimportant.VFirst,VtheVmaturityVgi
vesVtheVtimeVperiodVoverVwhichVtheVholderVofVtheVbondVcanVexpectVtoVreceiveVtheVcoup
on payments and the number of years before the principal will be paid in full. Second,
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marketVchange.VTheVvolatilityVofVaVbond’sVpriceVisVdependentVonVitsVmaturity.VMoreVspeci
fically,VwithVallVotherVfactorsVconstant,VtheVlongerVtheVmaturityVofVaVbond,VtheVgreaterVth
eVpriceVvolatilityVresultingVfromVaVchangeVinVmarketVyields.
ExplainVwhetherVorVnotVanVinvestorVcanVdetermineVtodayVwhatVtheVcashVflowVofVaVfl
oating-rateVbondVwillVbe.
Floating-
rateVbondsVareVissuesVwhereVtheVcouponVrateVresetsVperiodicallyVbasedVonVaVgeneralVfor
mulaVequalVtoVtheVreferenceVrateVplusVtheVquotedVmargin.VTheVreferenceVrateVisVsomeVi
ndexVsubjectVtoVchange.VTheVexactVchangeVisVunknownVandVuncertain.VThus,VanVinvestorV
cannotVdetermineVtodayVwhatVtheVcashVflowVofVaVfloating-
rateVbondVwillVbeVinVtheVfuture.
SupposeVthatVcouponVresetVformulaVforVaVfloating-rateVbondVis:V1-
monthVLIBORV+V130VbasisVpoints.
WhatVisVtheVreferenceVrate?
TheVreferenceVrateVisVtheV1-monthVLIBOR.
WhatVisVtheVquotedVmargin?
TheVquotedVmarginVisVtheV130VbasisVpointsV(orV1.30%).
SupposeVthatVonVcouponVresetVdateVthatV1-
monthVLIBORVisV2.4%.VWhatVwillVtheVcouponVrateVbeVforVtheVperiod?
TheVcouponVresetVformulaVis:V1-monthVLIBORV+V130VbasisVpoints.VSo,VifV1-
monthVLIBORVonVtheVcouponVresetVdateVisV2.4%,VtheVcouponVrateVisVresetVforVthatVperio
dVatV2.40%V+V1.30%V=V3.70%..
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WhatVisVaVdeferredVcouponVbond?
Deferred-
couponVbondsVareVcouponVbondsVthatVletVtheVissuerVavoidVusingVcashVtoVmakeVinterestVp
aymentsVforVaVspecifiedVnumberVofVyears.VThereVareVthreeVtypesVofVdeferred-
couponVstructures:
(1)Vdeferred-interestVbonds,V(2)Vstep-upVbonds,VandV(3)Vpayment-in-kindVbonds.
WhatVisVmeantVbyVaVlinker?
AVlinkerVisVaVbondVwhoseVinterestVrateVisVtiedVtoVtheVrateVofVinflation.VTheVU.S.VTreasuryVis
suesVlinkers,VandVtheyVareVreferredVtoVasVTreasuryVInflationVProtectionVSecuritiesV(TIPS).
AnswerVtheVbelowVquestions.
WhatVisVmeantVbyVanVamortizingVsecurity?
TheVprincipalVrepaymentVofVaVbondVissueVcanVbeVforVeitherVtheVtotalVprincipalVtoVbeVrep
aidVatVmaturityVorVforVtheVprincipalVtoVbeVrepaidVoverVtheVlifeVofVtheVbond.VInVtheVlatter
Vcase,VthereVisVaVscheduleVofVprincipalVrepayments.VThisVscheduleVisVcalledVanVamortizatio
nVschedule.VLoansVthatVhaveVthisVamortizingVfeatureVareVautomobileVloansVandVhomeVmort
gageVloans.VThereVareVsecuritiesVthatVareVcreatedVfromVloansVthatVhaveVanVamortizationVs
chedule.VTheseVsecuritiesVwillVthenVhaveVaVscheduleVofVperiodicVprincipalVrepayments.VSuc
hVsecuritiesVareVreferredVtoVasVamortizingVsecurities.
WhyVisVtheVmaturityVofVanVamortizingVsecurityVnotVaVusefulVmeasure?
ForVamortizingVsecurities,VinvestorsVdoVnotVtalkVinVtermsVofVaVbond’sVmaturity.VThisVisVbe
causeVtheVstatedVmaturityVofVsuchVbondsVorVsecuritiesVonlyVidentifiesVwhenVtheVfinalVprin
cipalVpaymentVwillVbeVmade.VForVanVamortizedVsecurity,VtheVrepaymentVofVtheVprincipalVi
sVmadeVthroughVmultipleVpaymentsVoverVitsVmaturityVandVnotVjustVatVtheVendVofVitsVter
mVtoVmaturity.VThus,VtheVmaturityVisVnotVaVusefulVmeasureVinVtermsVofVidentifyingVwhen
VtheVprincipalVisVrepaid.
