Question

# 1. Consider the following supply and demand for money of an economy: MS = 400 +...

1. Consider the following supply and demand for money of an economy:

MS = 400 + 20i

MD = 2000 – 30i

Find the equilibrium interest rate.

2. Consider the following savings and investment functions of an economy:

S = 40 + 5i

I = 400 – 3i

Find the equilibrium interest rate.

3. Consider the following Treasury quote:

104-13+/24+. If you are the seller of the bond, at what price will you sell?

4. Consider a bond paying an annual coupon of \$80 with a face value of \$1,000. Calculate the yield to maturity if the bond has 20 years remaining to maturity and is priced at \$1,200. What would be the holding period yield if the bond is held for 15 years and sold at \$1,100?

5. Suppose that you bought a 14% Drexler bond with time to maturity of 9 years for \$1,379.75 (semiannual coupons, interest rate=8%). After another ½ year, you sold the bond.

a. Assuming that the required rate of return remained at 8%, what would the selling price be? What is the rate of return from this investment?

b. Assuming that the required rate of return decreased to 7.5%, what would the selling price be? What is the rate of return from this investment?

6. Consider a five-year bond paying 10 percent coupon annually. The bond is priced at \$1,200.

a. Find the yield to maturity.

b. Find the realized yield, assuming that coupons are reinvested at the yield to maturity.

c. Find the realized yield, assuming that coupons are reinvested at the following rates: r0=9%, r1=9.5%, r2=10%, r3=10.5%, r4=11%, r5=11.5%.

d. Refer to part (c). Explain why the yield is different than the yield to maturity.

7. An 8 1/2 30-year US corporate bond is callable in 12 years. It is currently sold at a price of \$960. The call premium is 10 percent. The prevailing market interest rate at the call date is 8 percent.

a. What is the yield to call to an investor who does not reinvest the call price at the prevailing interest rate at the call date?

b. What is the yield to call to an investor who reinvests the call price at the prevailing interest rate at the call date?

8. Consider a 90-day Treasury bill whose price is 94.5%.

a. Find the yield on a discount basis.

b. Find the yield on a coupon equivalent basis. c. Find the effective yield.

Answer : 1) Given, money demand = 2000 - 30i

Money supply = 400 + 20i

At equilibrium, demand = supply

=> 2000 - 30i = 400 + 20i

=> 2000 - 400 = 20i + 30i

=> 1600 = 50i

=> i = 1600/50 = 32

Therefore, the interest rate at equilibrium is 32% .

2) Given , Saving (S) = 40 + 5i ;

Investment (I) = 400 - 3i

At equilibrium, Saving = Investment

=> 40 + 5i = 400 - 3i

=> 5i + 3i = 400 - 40

=> 8i = 360

=> i = 360/8 = 45

Therefore, the interest rate at equilibrium is 45%.

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