Unit 4 Assignment Questions AND ANSWERS 100% CORRECT FALL-2022 LATEST SOLUTION GUARANTEED GRADE A+

17. Impact of the Fed. Assume that the bond market participants suddenly expect the Fed to substantially increase the money supply. a. Assuming no threat of inflation, how would bond prices be affected by this expectation? Bond portfolio managers would expect a downward pressure of interest rates (Madura, 2013. In this case with no inflationary concerns, in increase in bond prices would be expected (Madura, 2013) b. Assuming that inflation may result, how would bond prices be affected? In a high-inflation market when the money supply is increased, it may actually cause a rise in interest rates due to a large increase in the demand for loanable funds (Madura, 2013). c. Given your answers to (a) and (b), explain why expectations of the Fed’s increase in the money supply may sometimes cause bond market participants to disagree about how bond prices will be affected. Some people may expect that an increase in the money supply may not increase inflation and will say rates will decrease (Madura, 2013). Others may think that the increase in the money supply will cause an increase in inflation which in turn causes interest rates (Madura, 2013). 24. Impact of the Credit Crisis on Risk Premiums. Explain how the prices of bonds were affected by a change in the risk-free rate during the credit crisis. Explain how bond prices were affected by a change in the credit risk premium during the credit crisis. Two things happened. First the risk free rate went down which placed an upward pressure on bond prices (Madura, 2013). Second, the risk premium increased which cause downward pressure on the prices (Madura, 2013). Problems: 1. Bond Valuation. 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? 110/(1+.11)1 + 110/(1+.11)2 + 110/(1+.11)3 + 1110/(1+.11)4 99.10 + 89.28 + 80.43 + 731.19 PV = 1000.00 b. If the required rate of return by investors were 14 percent instead of 11 percent, what would be the present value of the bond? 110 * (1-(1+0.14)-4)/.14) 110 * 2.9137 320.51 1000 * (1+.14)-4 1000 * (.5921) 592.10 PV = 912.61 c. If the required rate of return by investors were 9 percent, what would be the present value of the bond? 110 * (1-(1+.09)-4/.09) 110 * 3.2397 356.37 1000 * (1 + .09)-4 708.43 PV = 1064.80 2. Valuing a Zero-Coupon Bond. Assume the following information for existing zero-coupon bonds: Par value = $100,000 Maturity = 3 years Required rate of return by investors = 12% How much should investors be willing to pay for these bonds? 0 + 100,000(1+.12)-3 0 + 100,000(.7118) = 71,180 5. Predicting Bond Values. (Use the chapter appendix to answer this problem.) Bulldog Bank has just purchased bonds for $106 million that have a par value of $100 million, three years remaining to maturity, and an annual coupon rate of 14 percent. It expects the required rate of return on these bonds to be 12 percent one year from now. a. At what price could Bulldog Bank sell these bonds for one year from now? 14,000,000(1-(1+0.12)-2 )/.12) 14,000,000(1.6901) 23,661,400 100,000,000(1+.12)-2 100,000,000(.7972) 79,720,000 79,720,000 + 23,661,400 103,381,400 b. What is the expected annualized yield on the bonds over the next year, assuming they are to be sold in one year? 117,381,400 = 106,000,000(1 + n)1 .903 = (1 + n)1 = between 10% and 11% 11. Valuing a Zero-Coupon Bond. a. A zero-coupon bond with a par value of $1,000 matures in 10 years. At what price would this bond provide a yield to maturity that matches the current market rate of 8 percent? PV = 1000/(1+.08)10 PV = 463.19 c. What happens to the price of this bond if interest rates fall to 6 percent? PV = 1000/(1 + .06)10 PV = 558.39 d. Given the above changes in the price of the bond and the interest rate, calculate the bond price elasticity. = ((558.39 – 463.19)/463.19) / ((.06 - .08)/(.08)) = .20553/-.25 = -0.8221 12. Bond Valuation. You are interested in buying a $1,000 par value bond with 10 years to maturity and an 8 percent coupon rate that is paid semiannually. How much should you be willing to pay for the bond if the investor’s required rate of return is 10 percent? = 80 * (1 + .10)1 + 80 * (1 + .10)2 + 80 * (1 + .10)3 + 80 * (1 + .10)4 + 80 * (1 +.10)5 + 80 * (1 + . 10)6 + 80 * (1 + .10)7 + 80 * (1 + .10)8 + 80 * (1 + .10)9 + 80 * (1 +.10)10 = 88.00 96.80 106.48 117.13 128.84 141.72 155.90 171.49 188.64 207.50 1402.49 Internet Exercise: