Chapter 5

QUESTIONS: 5-4, 5-5

5-4 If you buy a callable bond and interest rates decline, will the value of your bond rise by as much as it would have risen if the bond had not been callable? Explain.

5-5 A sinking fund can be set up in one of two ways. Discuss the advantages and disadvantages of each procedure from the viewpoint of both the firm and its bondholders.

PROBLEMS: 5-6, 5-12, 5-20

5-6 The real risk-free rate is 3% and inflation is expected to be 3% for the next 2 years. A 2- year Treasury security yields 6.3%. What is the maturity risk premium for the 2 year security?

5-12 A 10-year, 12% semiannual coupon bond with a par value of $1,000 may be called in 4 years at a call price of $1,060. The bond sells for $1,100. (Assume that the bond has just been issued.)

a. What is the bond’s yield to maturity?

b. What is the bond’s current yield?

c. What is the bond’s capital gain or loss yield?

d. What is the bond’s yield to call?

5-20 Because of a recession, the inflation rate expected for the coming year is only 3%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3%. Assume tha the real risk-free rate is r* = 2% for all maturities and that there are no maturity premiums. If 3-year Treasury notes yield 2 percentage points more than1-year notes, what inflation rate is expected after Year 1?