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Essay on FNCE 4820 Fall 2013 Midterm 1 with Answers

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FNCE 4820 Fall 2013 NAME__________________
David M. Gross, Ph.D.
Midterm 1 with Answers

Answer the questions in the space below. Written answer requires no more than a few sentences.
Show your work to receive partial credit. Points are as indicated.

1. (9 Points) Briefly define the following in the context of holding a bond.

(a) Interest-Rate Risk
Risk of price change due to changes in the bond’s yield.

(b) Inflation Risk
Risk of earning a lower-than-expected real return if inflation exceeds expectations.

(c) Liquidity Risk
The risk of a large price drop if the bond must be sold quickly or the inability to sell quickly without incurring a large price drop.
Note: Liquidity Risk can also refer to the inability of a …show more content…

YTM = 4.6867%

(b) What is the Yield to First Call for the bond?
YTC = 4.4264%

(c) What is the Yield to Worst for the bond?
YTW = 4.4264%

7. (27 Points) A $1,000 face value bond makes semi-annual coupon payments. It has exactly 20 years to maturity. The yield to maturity is 7.50% and the coupon rate is 7.50%.

(a) Calculate the price of the bond.
N = 20 x 2 = 40; I/Y = 7.50/2 = 3.75; PMT = 0.075/2 x 1000 = 37.5; FV = 1000; PV = 1,000

(b) Compute BOTH the new lower price of the bond if the YTM increases by 100 basis point and the new higher price of the bond if the YTM decreases by 100 basis point.
N = 20 x 2 = 40; I/Y = (7.50 + 1.00)/2 = 4.25; PMT = 0.075/2 x 1000 = 37.5; FV = 1000; PV = 904.61
P+ = 904.61

N = 20 x 2 = 40; I/Y = (7.50 - 0.01)/2 = 3.25; PMT = 0.075/2 x 1000 = 37.5; FV = 1000; PV = 1,111.04
P- = 1,111.04

(c) Use your calculations from parts (a) and (b) to compute the approximate Modified Duration (D*) for the bond.
D* ≈ (P- - P+)/(2 x P0 x Δy) = (1,111.04 – 904.61)/(2 x 1000 x 0.01) = 10.32

(d) Calculate the actual dollar change in price of the bond for a 100 bps increase in yield.
N = 20 x 2 = 40; I/Y = (7.50 +

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