FIN 3303 1st Edition Lecture 9 Outline of Last Lecture I Price Risk and Interest Rate Risk a Examples II Callable Bond Outline of Current Lecture I Bonds II Quoted Interest Rate III Inflation Premium IV Default Risk Premium V Liquidity Premium VI Maturity Risk Premium VII Practice Problems with Premiums Current Lecture I II A level coupon bond is priced at a premium all else equal if it yields to maturity is higher than its coupon rate FALSE a If price par Priced at par b If price par Priced at premium c If price par Priced at discount d If YTM coupon rate Priced at par e If YTM coupon rate Price par f If YTM coupon rate Price par Quoted interest rate r r IP DRP LP MRP a Quoted interest rate Nominal interest rate b IP Inflation Premium c DRP Default Risk Premium d LP Liquidity Premium e MRP Maturity Risk Premium These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute III Practice Problems a You read in the Wall Street Journal that 30 day T Bills are currently yielding 5 5 Your brother in law a broker at safe and sound securities has given you the following estimates of current interest rate premiums i IP 3 25 ii LP 6 iii MRP 1 8 iv DRP 2 15 1 5 5 r 3 25 0 0 0 2 r 2 25 a All the premiums are 0 because it s a T Bill b The real risk free rate is 3 Inflation is expected to be 2 this year and 4 during the next 2 years Assume that maturity risk premium is zero What is the yield on 2 year treasury securities What is the yield on 3 year treasury securities i IP2 2 4 2 3 1 r2 3 3 6 ii IP3 2 4 4 3 3 33 1 r3 3 3 33 6 33 c A treasury bond that matures in 10 years has a yield of 6 A 10 year corporate bond has a yield of 8 Assume that liquidity premium on the corporate bond is 5 What is the default risk premium on the corporate bond i 6 r IP MRP ii 8 r IP MRP 5 DRP iii 8 6 5 DRP iv DRP 1 5 d You are considering a 10 year 1000 par value bond Its coupon rate is 9 and interest is paid semiannually If you require an effective annual interest rate not a nominal rate of 8 16 how much should you be willing to pay for the bond i EAR 1 r n m 1 ii 0816 1 r 2 2 1 iii 1 r 2 1 04 iv r 2 04 v r 08 vi 8 9 Premium price 1 N 20 I Y 4 PV 1067 95 PMT 45 FV 1000