Order Understanding Interest Rates Assignment

Order Understanding Interest Rates Assignment
*1. Would a dollar tomorrow be worth more to you today
when the interest rate is 20% or when it is 10%?
2. You have just won $20 million in the state lottery,
which promises to pay you $1 million (tax free) every
year for the next 20 years. Have you really won $20
million?
*3. If the interest rate is 10%, what is the present value of
a security that pays you $1,100 next year, $1,210 the
year after, and $1,331 the year after that?
4. If the security in Problem 3 sold for $3,500, is the
yield to maturity greater or less than 10%? Why?
*5. Write down the formula that is used to calculate the
yield to maturity on a 20-year 10% coupon bond with
$1,000 face value that sells for $2,000.
6. What is the yield to maturity on a $1,000-face-value
discount bond maturing in one year that sells for
$800?
*7. What is the yield to maturity on a simple loan for $1
million that requires a repayment of $2 million in five
years’ time?
8. To pay for college, you have just taken out a $1,000
government loan that makes you pay $126 per year
for 25 years. However, you don’t have to start making
these payments until you graduate from college two
years from now. Why is the yield to maturity necessarily less than 12%, the yield to maturity on a normal
$1,000 fixed-payment loan in which you pay $126
per year for 25 years?
*9. Which $1,000 bond has the higher yield to maturity, a
20-year bond selling for $800 with a current yield of
Order Understanding Interest Rates Assignment
15% or a one-year bond selling for $800 with a current yield of 5%?
QUIZ
10. Pick five U.S. Treasury bonds from the bond page of
the newspaper, and calculate the current yield. Note
when the current yield is a good approximation of the
yield to maturity.
*11. You are offered two bonds, a one-year U.S. Treasury
bond with a yield to maturity of 9% and a one-year
U.S. Treasury bill with a yield on a discount basis of
8.9%. Which would you rather own?
12. If there is a decline in interest rates, which would you
rather be holding, long-term bonds or short-term
bonds? Why? Which type of bond has the greater
interest-rate risk?
*13. Francine the Financial Adviser has just given you the
following advice: “Long-term bonds are a great investment because their interest rate is over 20%.” Is
Francine necessarily right?
14. If mortgage rates rise from 5% to 10% but the
expected rate of increase in housing prices rises from
2% to 9%, are people more or less likely to buy
houses?
*15. Interest rates were lower in the mid-1980s than they
were in the late 1970s, yet many economists have
commented that real interest rates were actually much
higher in the mid-1980s than in the late 1970s. Does
this make sense? Do you think that these economists
are right?