Questions marked with an asterisk are answered at the end of the book in an appendix, "Answers to Selected Questions and Problems."
*1. Would a dollar tomorrow be worth more to you today when the interest rate is 20% or when it is 10%?
2. You have just won $20 million in the state lottery, which promises to pay you $1 million (tax free) every year for the next 20 years. Have you really won $20 million?
*3. If the interest rate is 10%, what is the present value of a security that pays you $1,100 next year, $1,210 the year after, and $1,331 the year after that?
4. If the security in Problem 3 sold for $3,500, is the yield to maturity greater or less than 10%? Why?
*5. Write down the formula that is used to calculate the yield to maturity on a 20-year 10% coupon bond with $1,000 face value that sells for $2,000.
6. What is the yield to maturity on a $1,000-face-value discount bond maturing in one year that sells for $800?
*7. What is the yield to maturity on a simple loan for $1 million that requires a repayment of $2 million in five years' time?
8. To pay for college, you have just taken out a $1,000 government loan that makes you pay $126 per year for 25 years. However, you don't have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than 12%, the yield to maturity on a normal $1,000 fixed-payment loan in which you pay $126 per year for 25 years?
*9. Which $1,000 bond has the higher yield to maturity, a 20-year bond selling for $800 with a current yield of 15% or a one-year bond selling for $800 with a current yield of 5%?
10. Pick five U.S. Treasury bonds from the bond page of the newspaper, and calculate the current yield. Note when the current yield is a good approximation of the yield to maturity.
*11. You are offered two bonds, a one-year U.S. Treasury bond with a yield to maturity of 9% and a one-year U.S. Treasury bill with a yield on a discount basis of 8.9%. Which would you rather own?
12. If there is a decline in interest rates, which would you rather be holding, long-term bonds or short-term bonds? Why? Which type of bond has the greater interest-rate risk?
*13. Francine the Financial Adviser has just given you the following advice: "Long-term bonds are a great investment because their interest rate is over 20%." Is Francine necessarily right?
14. If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy houses?
*15. Interest rates were lower in the mid-1980s than they were in the late 1970s, yet many economists have commented that real interest rates were actually much higher in the mid-1980s than in the late 1970s. Does this make sense? Do you think that these economists are right?
1. Investigate the data available from the Federal Reserve at www.federalreserve.gov/releases/. Answer the following questions:
a. What is the difference in the interest rates on commercial paper for financial firms when compared to nonfinancial firms?
b. What was the interest rate on the one-month Eurodollar at the end of 2002?
c. What is the most recent interest rate report for the 30-year Treasury note?
2. Figure 1 in the text shows the estimated real and nominal rates for three-month treasury bills. Go to www.martincapital.com/charts.htm and click on "interest rates and yields," then on "real interest rates."
a. Compare the three-month real rate to the long-term real rate. Which is greater?
b. Compare the short-term nominal rate to the long-term nominal rate. Which appears most volatile?
3. In this chapter we have discussed long-term bonds as if there were only one type, coupon bonds. In fact there are also long-term discount bonds. A discount bond is sold at a low price and the whole return comes in the form of a price appreciation. You can easily compute the current price of a discount bond using the financial calculator at http://app.ny.frb.org/sbr/.
To compute the redemption values for savings bonds, fill in the information at the site and click on the Compute Values button. A maximum of five years of data will be displayed for each computation.
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