Besley Chapter 7.ppt

Besley: Chapter 7 Homework #4 Pg. 324 7-1 Pg. 325 7-7 Pg. 328 7-14 Pg. 324 7-1 Suppose Ford Motor Company sold an issue of bonds with a ten-year maturity, a $1,000 par value, a ten percent coupon rate, and semiannual interest payments. Two years after the bonds were issued, the going rate of interest on bonds such as these fell to 6%. At what price would the bonds sell. Bond Value = INT(PVIFA3%,16) + M(PVIF3%,16) = 50(12.5611) + 1,000(0.6232) = $1,251.26 Pg. 324 7-1 Suppose that, two years after the initial offering, the going interest rates had risen to 12%. At what price would the bond sell? Pg. 324 7-1 Suppose that the conditions in part (a) existed – that is, interest rates fell to six percent two years after the issue date. Suppose further that the interest rate remained at six percent for the next eight years. Describe what would happen to the price of the of the Ford Motor Company bonds over time. The price of the bond will decline toward $1,000. Page 325 7-7 In January of 1994, the yield on AAA rated corporate bonds averaged about 5%; by the end of the year the yield on these same bonds was about 8% because the Federal Reserve increased interest rates six times during the year. Assume IBM issued a 10-year, 5% coupon bond on January 1, 1994. On the same date, General Motors issued a 20-year, 5% coupon bond. Both bonds pay interest annually. Also assume that the market rate on similar risk bonds was 5% at the time the bonds were issued. Page 325 7-7 Compute the market value of each bond at the time of issue. Both bonds would have sold at par since the coupon rate was equal to the original YTM. N=10; I=5%; PMT=50; FV=1,000 Compare the market value of each bond one year after issue if the market yield for similar risk bonds was 8% in 1/1/95. VIBM=50(6.2469)+1,000(0.5002) = $812.55 VGM=50(9.6036)+1,000(0.2317) = $711.88 Page 325 7-7 Compute the 1994 capital gains yield for each bond. Capital GainsIBM=(812.55-1,000)/1,000=-18.75% Capital GainsGM=(7