price could sun devil savings sell B u s i n e s s F i n a n c e

1. An inflationindexed Treasury bond has a par value of $1,000
and a coupon rate of 6 percent. An investor
purchases this bond and holds it for one year.
During the year, the consumer price index increases
by 1 percent every six months. What are the total
interest payments the investor will receive during
the year?

2. Assume that the
U.S. economy experienced deflation during the year and
that the consumer price index decreased by 1 percent in
the first six months of the year and by 2 percent during the
second six months of the year. If an investor had purchased inflation-indexed Treasury bonds with a par value
of $10,000 and a coupon rate of 5 percent, how much
would she have received in interest during the year?

3. Assume the following information
for an existing bond that provides annual coupon
payments:
Par value ¼ $1,000
Coupon rate ¼ 11%
Maturity ¼ 4 years
Required rate of return by investors ¼ 11%
a. What is the present value of the bond?

b. If the required rate of return by investors was
14 percent instead of 11 percent, what would be the
present value of the bond?
c. If the required rate of return by investors was
9 percent, what would be the present value of the
bond?

4. Valuing a Zero-Coupon Bond Assume the following information for existing zero-coupon bonds:
Par value ¼ $100,000
Maturity ¼ 3 years
Required rate of return by investors ¼ 12%
How much should investors be willing to pay for
these bonds?

5. Assume that you
require a 14 percent return on a zero-coupon bond
with a par value of $ 1,000 and six years to maturity.
What is the price you should be willing to pay for this
bond?

6. Cardinal Company, a U.S.-based insurance company, considers purchasing bonds denominated in Canadian dollars, with a maturity of six years, a
par value of C$50 million, and a coupon rate of 12 percent. Cardinal can purchase the bonds at par. The current exchange rate of the Canadian dollar is $0.80.
Cardinal expects that the required return by Canadian
investors on these bonds four years from now will be
9 percent. If Cardinal purchases the bonds, it will sell
them in the Canadian secondary market four years from
now. It forecasts the exchange rates as follows:

YEAR EXCHANGE
RATE OF C$ YEAR EXCHANGE
RATE OF C$

1 $0.80 4 $0.72

2 0.77 5 0.68

3 0.74 6 0.66

a. Refer to earlier examples in this chapter to determine the expected U.S. dollar cash flows to Cardinal
over the next four years.

b. Does Cardinal expect to be favorably or adversely
affected by the interest rate risk? Explain.

c. Does Cardinal expect to be favorably or adversely
affected by exchange rate risk? Explain.

7. (Use the chapter appendix to answer this problem.) Bulldog Bank has just
purchased bonds for $106 million that have a par value
of $100 million, three years remaining to maturity, and
an annual coupon rate of 14 percent. It expects the
required rate of return on these bonds to be 12 percent
one year from now.

a. At what price could Bulldog Bank sell these bonds
one year from now?

b. What is the expected annualized yield on the bonds
over the next year, assuming they are to be sold in one
year?

8. (Use the chapter appendix
to answer this problem.) Sun Devil Savings has just
purchased bonds for $38 million that have a par value of
$40 million, five years remaining to maturity, and a
coupon rate of 12 percent. It expects the required rate of
return on these bonds to be 10 percent two years from now.

a. At what price could Sun Devil Savings sell these
bonds two years from now?

b. What is the expected annualized yield on the bonds
over the next two years, assuming they are to be sold in
two years?

c. If the anticipated required rate of return of 10 percent in two years is overestimated, how would the
actual selling price differ from the forecasted price?
How would the actual annualized yield over the next
two years differ from the forecasted yield?

9. (Use the chapter appendix
to answer this problem.) Spartan Insurance Company
plans to purchase bonds today that have four years
remaining to maturity, a par value of $60 million, and a
coupon rate of 10 percent. Spartan expects that in three
years, the required rate of return on these bonds by
investors in the market will be 9 percent. It plans to sell
the bonds at that time. What is the expected price it will
sell the bonds for in three years?

10. (Use the chapter appendix to answer
this problem.) Hankla Company plans to purchase
either (1) zero-coupon bonds that have 10 years to
maturity, a par value of $100 million, and a purchase
price of $40 million; or (2) bonds with similar default
risk that have five years to maturity, a 9 percent coupon rate, a par value of $40 million, and a purchase
price of $40 million.
Hankla can invest $40 million for five years.
Assume that the market’s required return in five years
is forecasted to be 11 percent. Which alternative would
offer Hankla a higher expected return (or yield) over
the five-year investment horizon?