Week 4


In this week we learn about bonds and expectation theory.

The Essentials

What is a bond?

Question 1

Wesfarmers P/L has issued bonds earning a 7% p.a. coupon rate. The interest is paid semi-annually and the bonds mature in eight years.  Each bond’s face value is $1,000. If your required rate of return is 8% p.a. what is the price you should pay for each of the bonds?

Question 2

You have just purchased 10 newly-issued $100 five year Avco Ltd. debentures at par. These debentures pay $6 (per debenture) in interest semi-annually. You are also negotiating the purchase of 10 $100 debentures issued by Sabco Ltd. four years ago that return $3 per debenture in semi-annual interest payments and have six years remaining to maturity. What is the maximum price you should offer for the Sabco Ltd. debentures assuming Sabco Ltd. is now in the same risk class as Avco Ltd.?

Question 3

If at T0 the one-period rate of interest is 6%, the two-year rate is 8% p.a., and the three-year rate is 10% p.a., what is the two-period per annum interest rate expected to prevail at T1?

Question 4

Using semi-annual compounding a 15 year zero-coupon bond that has a face value of $1,000 and a required return of 8% p.a. would be priced at:

a. $308
b. $315
c. $464
d. $555

Question 5

You buy a two-year bond that pays interest of 12% p.a. At the end of year two you purchase a one-year bond that pays interest of 10%. According to the expectations theory of interest rates you could have purchased a three-year bond today that pays interest each year of:

a. 11.0%
b. 11.3%
c. 11.5%
d. cannot be determined

Question 6

Which of the following statements is most correct?

a. All else equal, if a bond’s yield to maturity increases its current yield will fall.
b. All else equal, if a bond’s yield to maturity increases its price will fall.
c. If a bond’s yield to maturity exceeds the coupon rate the bond will sell at a premium.
d. All of the answers above are correct.

Question 7

Two years ago you bought a Commonwealth Government bond for $1,000 because you liked the 10% p.a. coupon interest payment that you would receive for 10 years. Interest on the bond is paid annually. Two years later when the market interest rate has fallen to 8% p.a. what is the value of your Commonwealth Government bond?

I am here to Assist You

This help form is only available for subscription members