(Questions are in bold print followed by answers.)
1. What is the cash flow of a 8-year bond that pays coupon interest semiannually, has a coupon rate of 6%, and has a par value of $100,000?
The principal or par value of a bond is the amount that the issuer agrees to repay the bondholder at the maturity date. The coupon rate multiplied by the principal of the bond provides the dollar amount of the coupon (or annual amount of the interest payment). An 8-year bond with a 6% annual coupon rate and a principal of $100,000 will pay semiannual interest of (0.06/2)($100,000) = $3,000 for 8(2) = 16 periods. Thus, the cash flow is $3,000. In addition to this periodic cash, the issuer of the bond is obligated to pay back the principal of $100,000 at the time the last $3,000 is paid.
5. Suppose that coupon reset formula for a floating-rate bond is: 1-month LIBOR + 130 basis points.
(a) What is the reference rate?
The reference rate is the 1-month LIBOR.
(b) What is the quoted margin?
The quoted margin is the 130 basis points (or 1.30%).
(c) Suppose that on coupon reset date that 1-month LIBOR is 2.4%. What will the coupon rate be for the period?
The coupon reset formula is: 1-month LIBOR + 130 basis points. So, if 1-month LIBOR on the coupon reset date is 2.4%, the coupon rate is reset for that period at 2.40% + 1.30% = 3.70%..
11. Answer the below questions.
(a) What is the advantage of a call feature for an issuer?
Inclusion of a call feature benefits bond issuers by allowing them to replace an old bond issue with a lower-interest cost issue if interest rates in the market decline. A call provision effectively allows the issuer to alter the maturity of a bond. The right to call an obligation is included in most loans and therefore in all securities created from such loans. This is because the borrower typically has the right to pay off a loan at any time, in whole or in part, prior to the stated maturity date of the...
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