Question

1. If 9-year T-bonds have a yield of 2.9%, 9-year A-rated corporate bonds yield 4.8%, the maturity risk premium on all 9-year bonds is 1.2%, and A-rated corporate bonds have a 0.6% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?

2. You project that you will need $50,000 in 9 years to put a down payment on a home on a conventional mortgage program. You plan to save for this by putting money away monthly and expect to earn a 7% APY (annual percentage yield) on your money. How much do you need to save monthly?

3. Which of the following is NOT correct?

Select one:

a. If a bond's yield to maturity exceeds its coupon rate, the bond's price must be less than par value.

b. If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected capital gains yield is zero.

c. All else equal, if a bond's yield to maturity decreases, its price will fall.

d. The total rate of return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year, divided by the bond's price at the beginning of the year.

e. All else equal, long-term bonds have more interest rate risk (also known as price risk) than short-term bonds.

Answer 1

1: Corporate bond yield = T bonds Yield + Liquidity premium + Default risk premium

4.8%= 2.9%+0.6%+ DRP

DRP = 1.3%

2: Using financial calculator

Input: FV = 50000 , N = 9*12 = 108 ; I/Y =9/12

Solve for PMT as -302.15

Hence monthly saving = $302.15

3: c

a is correct

(Since the return on bond is less than market expectation, its price will be lesser)

B is correct

(Since The price equal par value, current yield = dividend/ Par value which is the same as coupon rate which is the same as YTM)

C is FALSE

As the YTM decreases, the price increases.

D is Correct

Total return = Dividend yield + capital gains yield

E is correct

Higher the maturity higher is the risk of changes in interest rates.