Homework

1. Suppose a 2-year 8% semiannual coupon bond is priced at $98.19 to yield 7% currently

(par is $100), compute the percentage of returns from reinvestment income in total dollar
returns.
2. Suppose a 4-year 6% semi-annual coupon bond is traded to yield 8% currently (par is
$100),
(A) Compute the price of the bond currently;
(B) Compute the percentage of returns from reinvestment income in total dollar
returns.
3. Suppose that an investor invests $108.32 in a 5-year certificate of deposit that pays 7%
annually (on a bond-equivalent basis) or 3.5% semiannually and the interest payments are
semiannual.
a. What are the total future dollars of this investment at the end of 5 years (i.e., ten
6-month periods)?
b. How much total interest is generated from the investment in this certificate of
deposit?
4. Suppose an investor can purchase a 5-year 9% coupon bond that pays interest
semiannually and the price of this bond is $108.32. The yield to maturity for this bond is
7% on a bond-equivalent basis.
a. What is the total future dollars and the total dollar return that will be generated
from this bond if it is to yield 7%?
b. What is the percentage of returns from reinvestment income in total dollar
returns.
5. Consider a BB-rated bond that has a YTM of 6% and a modified duration of 6.46.What
is the expected return on the bond over the next year given the partial credit transition and
credit spread as given below, assuming that market spreads and yields will remain stable
over the year?
One-year transition matrix for BB rated bonds and credit spreads:
AAA AA A BBB BB B CCC
Probability (%) 0.02 0.30 4.80 6.73 75.95 7.75 4.45
Credit Spread 0.60% 0.90% 1.10% 1.50% 4.40% 7.52% 13.58%

6. Given the information in the following table:

Bond Probability of Default (%) at t=1 Recovery rate (%)

 A 0.75 40
B 0.90 35
C 0.80 30
Assumption: discount rate of 3% for each of the period
a. Compute the CVA for a 3-year zero-coupon $100 face value corporate bond
b. Compute fair value of each bond
c. Compute the credit spread of each bond
7. A fixed-income trader at a hedge fund observes a 4-year, 5% annual payment corporate
bond trading at 106 per 100 of par value. The research team at the hedge fund determines
that the risk-neutral probability of default used to calculate the conditional POD for each
date for the bond is 2% given the recovery rate of 45%. The government bond yield curve
is flat at 3.50%. Calculate the fair value and credit spread for the bond.