FINANCE Investment Analysis and Portfolio Management CHAPTER 18 QUESTIONS AND PROBLEMS
1 Why does the present value equation appear to be more useful for the bond investor than for the common stock investor?
2. What are the important assumptions made when you calculate the promised yield to maturity? What are the assumptions when calculating promised YTC ?
3. a. Define the variables included in the following model ：
i =(RFR,I,RP)
b. Assume that the firm whose bonds you are considering is not expected to bleak even this year. Discuss which factor will be affected by this information.
4. We discussed three alternative hypotheses to explain the term structure of interest rates. Briefly discuss the three hypotheses and indicate which one you think best explains the alternative shapes of a yield curve.
7. You expect interest rates to decline over the next six months
a. Given your interest rate outlook, state what kinds of bonds you want in your portfolio in terms of duration and explain your reasoning for this choice.
b. Y ou must make a choice between the following three sets of noncallable bonds. For each set select the bond that would be best for your portfolio given your interest rate outlook and the consequent strategy set forth in Part a. In each case briefly discuss why you selected the bond.
Bonds; Maturity; Coupon; Yield to Maturity
Set 1 ： Bond A 15 years 10% 10%
Bond B 15 years 6% 8%
Set 2 ： Bond C 15 years 6% 10%
Bond D 10 years 8% 10%
Set 3 ： Bond E 12 years 12% 12%
Bond F 15 years 12% 8%
8. At the present time, you expect a decline in interest rates and must choose between two portfolios of bonds with the following characteristics ：
Portfolio A Portfolio B
Average maturity 10.5 years 10.0 years
Average YTM 7% 10%
Modified duration 5.7 years 4.9 years
Modified convexity 125.18 40.30
Call features Noncallable Deferred call features that range from 1 to 3 years Select one of the portfolios and discuss three factors that would justify your selection.
9. The Chartered Finance Corporation has issued a bond with the following characteristics ： Maturity--25 years
Coupon--9%
Yield to maturity--9%
Callable--after 3 years@109
Duration to maturity--8.2 years
Duration to first call--2.1 years
a. Discuss the concept of call-adjusted duration and indicate the approximate value (range) for it at the present time.
b. Assuming interest rates increase substantially (i.e., to 13 percent), discuss what will happen to the call-adjusted duration and the reason for the change.
c. Assuming interest rates decline substantially (i.e., they decline to 4 percent),discuss what will happen to the bond's call-adjusted duration and the reason for the change.
d. Discuss the concept of negative convexity as it relates to this bond.
PROBLEMS
1. Four years ago ， your firm issued $1,000 par, 25-year bonds, with a 7 percent coupon rate and a 10 percent call premium.
a. lf these bonds are now called, what is the approximate yield to call for the investors who originally purchased them?
b. If these bonds are now called, what is the actual yield to call for the investors who originally purchased them at par?
c If the current interest rate is 5 percent and the bonds were not callable, at what price would each bond sell?
2. Assume that you purchased an 8 percent, 20-year,$1,000 par, semiannual payment bond priced at $l,012.50 when it has 12 years remaining until maturity. Compute ：
a. Its promised yield to maturity
b. Its yield to call if the bond is callable in three years with an 8 percent premium.
3. Calculate the duration of an 8 percent, $1,000 par bond that matures in three years if the bond's YTM is 10 percent and interest is paid semiannually.
a. Calculate this bond's modified duration.
b. Assuming the bond's YTM goes from 10 percent to 9.5 percent calculate an estimate of the price change.
4. Two years ago, you acquired a 10-year zero coupon,$ 1,000 par value bond at a 12 percent YTM Recently you sold this bond at an 8 percent YTM. Using semiannual compounding, compute the annualized horizon return for this investment.
5. A bond for the Chelle Corporation has the following characteristics ：
Maturity--12 years
Coupon--10%
Yield to maturity--9.50%
Macaulay duration--5.7 years
Convexity--48
Noncallable
a. Calculate the approximate price change for this bond using only its duration assuming its yield to maturity increased by 150 basis points. Discuss the impact of the calculation including the convexity effect.
b. Calculate the approximate price change for this bond (using only its duration) if its yield to maturity declined by 300 basis points. Discuss (without calculations) what would happen to your estimate of the price change if this was a callable bond.
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