Question

Assume that a 8-year, 8% bond is callable after 5 years at 105% of par value and the discount rate in today’s market is 5%. Using the price-to-worst method, what is the value of this bond?

A) 1,000

B) 1,149

C) 1,170

D) 1,268

E) 1,010

An upward sloping yield curve means that:

A) Investors require lower returns for longer maturity Treasuries.

B) Investors require higher returns for longer maturity Treasuries.

C) Investors require higher returns for shorter maturity Treasuries.

D) Investors require the same return for both short and long-term Treasuries.

E) The yield curve is not related to required return on Treasuries.

Answer 1

1. Option (C)

Yield to Call = [Interest + (Call price - Purchase price)/n] / [(Call price + Purchase price)/2]

0.05 = [80 +(1050 - PP)/5] / [(1050+PP)/2]

0.05 = [(400+1050-PP)/5] / [(1050+PP)/2]

0.05 = [2*(400+1050-PP)] / [5*(1050+PP)]

0.05 = (800+2100-2*PP)/(5250+5*PP)

0.05*(5250+5*PP) = 2900-2*PP

262.50 + 0.25*PP =2900 - 2*PP

2*PP + 0.25*PP = 2900 - 262.50

2.25*PP = 2637.50

PP = 2637.50/2.25

PP = 1172 or 1170

Hence, Value of Bond is 1170

2. Option (B)

An upward slope yield curve indicates yields on longer-term bonds may continue to rise, responding to periods of economic expansion. When investors expect longer-maturity bond yields to become even higher in the future, many would temporarily park their funds in shorter-term securities in hopes of purchasing longer-term bonds later for higher yields.