Fall 2007

FINANCIAL MARKETS Master International and Corporate Finance (ISC Paris) and Risk Management in Finance and Insurance (University of Cergy-Pontoise) Prof. Duc K. Nguyen 25a, ISC2, ISC Paris School of Management [email protected] http://khuongnguyen.free.fr/

LIST OF APPLICATIONS Investing in Bond Markets STUDY PROBLEMS Problem 1 Exxon 20-year bonds pay 9 percent interest annually on a $1,000 par value. If bonds sell at $945, what is the bond’s expected return? Problem 2 Barbara owns a Treasury bond which pays a semi-annual coupon of $45. The bond will mature in 7 years and will repay the principal of $1,000 at maturity. If the yield curve shows that 7-year Treasuries have yields of 8% at the current time, how much is Barbara's bond worth? Problem 3 National Steel 15-year, $1,000 par value bonds pay 8 percent interest annually. The market price of the bond is $1,085, and your required rate of return is 10 percent. a. Compute the bond’s expected return b. Determine the value of the bond to you, given your required rate of return c. Should you purchase the bond? Problem 4 You own a bond that pays $100 in annual interest, with a $1,000 par value. It matures in 15 years. Your required rate of return is 12 percent. a. Calculate the value of the bond b. How does the value change if your required rate of return (i) increases to 15 percent or (ii) decreases to 8 percent? Problem 5 Suppose your portfolio is composed of the following bonds: Bond Years to maturity Annual interest Maturity value P 5 $100 $1,000 Q 5 $70 $1,000 R 10 $120 $1,000 S 10 $80 $1,000 T 15 $65 $1,000 a. If your required rate of return is 10 percent, calculate the value and the duration for each of these bonds. b. Comment the obtained result. Problem 6 Following you will find data on $1,000 par value bonds issued by Bank of America, Hilton Hotels and Time Warner at the end of 2005. Bank of America Hilton Hotels Time Warner Coupon interest rate 7.8% 7.5% 7.975 Years to maturity 10 17 4 Assume you are thinking about buying these bonds as of January 2006. Answer the following question for each of these bonds: a. Calculate the value of the bonds if your required rates of return are as follows: Bank of America (6%), Hilton Hotels (9%) and Time Warner (8%). b. What were the expected rates of return for each of these bonds if they were selling for the following amounts: Bank of America ($1,030), Hilton Hotels ($973) and Time Warner ($1,035). c. Compute the duration for each of these bonds. Interpret your results. d. Should you buy the bonds?

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