1. Which, if any, of the following statements are false? A. For a given coupon r
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Question
1. Which, if any, of the following statements are false?
A. For a given coupon rate, the sensitivity of bond prices to changes in interest rates increases at an increasing rate as maturity increases.
B. For a given absolute change in interest rates from the same base level, the proportionate increase in bond prices when rates fall is larger than the proportionate decrease in bond prices when rates rise.
C. For identical coupon rates and a given absolute change in interest rates from the same base level, long-term bonds change proportionately more in price than short-term bonds.
D. For identical maturities and a given absolute change in interest rates from the same base level, low-coupon bonds change proportionately less in price than high-coupon bonds.
2. What are the duration and modified duration of a seven-year, 3.5 percent coupon rate, annual coupon payment, $1000 par value government note priced today to yield 3 percent to maturity (use the text formulas or Excel’s Duration and MDuration functions)? What is the convexity of this instrument? [Recall that Bonds and Bond Properties.xls illustrates these calculations.] Using one of the following approximation formulas with yield data in decimal form,
[if text formula] % Change in Price 100 (-1.0 Duration (YieldNew-YieldOld)/(1+YieldOld)),
[if Excel function] % Change in Price 100 (-1.0 MDuration (YieldNew-YieldOld)),
what is the approximate percentage change in this bond's price if yields on comparable securities rise to 4 percent? What is the actual percentage change in this bond's price if yields on comparable securities rise to 4percent (use a financial calculator or Excel’s PV function)?
3. Consider the dividend discount model, the capital asset pricing model, the arbitrage pricing model and the firm valuation model. If these accurately portray the intrinsic values of stock prices and stock returns, then what is the corresponding fundamental relationship between stock prices and interest rates? Explain your answers.
Explanation / Answer
Q.1.
Answer A and B.
Q.2.
Answer 3.
When interest rates increases, it means bank has to borrow money from controlling bank at an increased interest rate. Same way banks also increase interest rate to lend money to business or others. These effects the spendings, as everyone has to pay their bills.
Businesses houses are also indirectly affected by an increase in the interest rate as a result of individuals effected spendings. Businesses are affected in a more direct way as well. They too have to borrow money from banks to run and expand their operations. When the banks make borrowing more expensive, companies might not borrow as much and will pay higher rates of interest on their loans. Less business spending can slow down the growth of a company, resulting in decreases in profit.
So , it is clear that increase in the interest rate effects the stock price. Because the income is going to change over time due to change of interest price of stock is also changed as the price is calculated as the present value of future cash flows.
PV Factor Present Year cashflow at 3% Value Weight MacD 1 35 0.970874 33.98 3.30% 0.03 56.17 2 35 0.942596 32.99 3.20% 0.06 163.59 3 35 0.915142 32.03 3.11% 0.09 317.65 4 35 0.888487 31.10 3.02% 0.12 514.00 5 35 0.862609 30.19 2.93% 0.15 748.54 6 35 0.837484 29.31 2.84% 0.17 1017.44 7 1035 0.813092 841.55 81.61% 5.71 38947.76 Total 1245 1031.15 100.00% 6.34 Modified Duration = MacD x 6.34/(1+3/100)=6.16% formula for 'Convexity C=1/(1+y)^2 x PV x (t^2 + t) Yield if bond yields 4% PV Factor Present Year cashflow at 3% Value 1 0.4 0.970874 0.39 2 0.4 0.942596 0.38 3 0.4 0.915142 0.37 4 0.4 0.888487 0.36 5 0.4 0.862609 0.35 6 0.4 0.837484 0.33 7 1040 0.813092 845.62 Total 1042.4 847.78 Change in Price (1013.15-847.78 183.37 %age of Change (183.37/1031.15) 17.78%Related Questions
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