Possible Essay Questions for Mini-Exam 4

Part I: Bond Valuation Questions similar to the ones below. You will have to memorize the equations.

Part II: Essay Questions from the list below or Multiple Choice Questions based on the essay questions listed below (or both essay questions and multiple choice).

It will begin 5 minutes after the start of class and will only last about 30 minutes.

- What is an estimate of the price of AAA-rated bond that has nine years till maturity, a face value of 1000 dollars, and an APR coupon rate of 18 percent? Assume that the coupon payments are made
, and that the current market interest rate for AAA-rated, 9-year maturity bonds is 10 percent APR compounded annually. Show your work.*annually (at the end of each year)*

Cash payment per Period *

= 180 *= 1036.62 (Present Value of the Annuity Component)

Present Value of a Lump Sum

Hence, price is 1460.71

- Shift clear all
- 1 shift PMT
- 9 N
- 10 I/yr
- -180 PMT
- 0 FV
- PV (this gives PV of annuity)
- 0 PMT
- -1000 FV

10) PV (this gives PV of lump sum)

11) add 7 and 11 together

- What is an estimate of the price of AAA-rated bond that has nine years till maturity, a face value of 1000 dollars, and an APR coupon rate of 18 percent? Assume that the coupon payments are made
, and that the current market interest rate for AAA-rated, 9-year maturity bonds is 10 percent APR compounded semi-annually. Show your work.*semi-annually (at the end of each 6 months)*

Cash payment per Period *

= 90 *= 1052.06 (Present Value of the Annuity Component)

Present Value of a Lump Sum

Hence, price is 1467.58

- Shift clear all
- 2 shift PMT
- 9 shift N
- 10 I/yr
- -90 PMT
- 0 FV
- PV (this is the value of the annuity component)
- 0 PMT
- -1000 FV
- PV (This is the value of the lump sum)
- Add 7 and 11 together

- The Apr coupon rate on a bond is 6 percent (compounded quarterly) and yet the yield to maturity on the bond is 10 percent (compounded quarterly). The face value of the bond is 1000 dollar and will mature in 7 years. What is the price of the bond right now?

Cash payment per Period *

= 15 *= (Present Value of the Annuity Component—will do in class)

Present Value of a Lump Sum

(Present Value of Lump Sum—will do in class)

Add value of annuity component and lump sum and you have the price (price should be well below 1000 dollars as the coupon rate is much less than the yield to maturity)

- Shift clear all
- 4 shift PMT
- 7 shift N
- 10 I/yr
- -15 PMT
- 0 FV
- PV (this is the value of the annuity component)
- 0 PMT
- -1000 FV
- PV (This is the value of the lump sum)
- Add 7 and 11 together

Possible Essay Questions

- Explain the Babysitting Story. How does this example help us understand monetary economics?
- Why is hyperinflation so hard to stop?
- Explain how municipal bonds are different from corporate bonds?
- Define the following terms: coupon rate, yield, maturity, face value, discount bond, premium bond
- Why is there an inverse relationship between seasoned coupon bond prices and yields?
- Why is the yield and the coupon rate of a brand new issue bond equal?
- News comes out today that the economy is much weaker than expected. Hence, this changes the expectation of future interest rates. What will happen to U.S. Treasury Bond Prices and Yields todayas a result of the news? You will need to use the Mishkin and Eakins (in lecture 6) analysis in your answer and correctly
.__label the graph__ - News comes out today that inflation is greater than expected. Hence, this changes the expectation of future interest rates. What will happen to U.S. Treasury Bond Prices and Yields today as a result of the news? You will need to use the Mishkin and Eakins (in lecture 6) analysis in your answer and correctly
.__label the graph__ - News comes out today that suggests that the stock market is much more attractive than before (corporate earnings have gone up greatly).What will happen to U.S. Treasury Bond Prices and Yields today as a result of the news? You will need to use the Mishkin and Eakins (in lecture 6) analysis in your answer and correctly
.__label the graph__ - News comes out today that suggests that the stock market is much less attractive than before (corporate earnings have gone down greatly).What will happen to U.S. Treasury Bond Prices and Yields today as a result of the news? You will need to use the Mishkin and Eakins (in lecture 6) analysis in your answer and correctly
.__label the graph__ - Why does a flat or downward sloping yield curve usually predict a recession? Explain.(long answer required)
- What is interest rate risk? Explain.
- What type of bonds have more interest rate risk? Why?
- What is a callable bond?
- How do you calculate stand-alone expected return?
- How to you calculate stand-alone risk?
- Explain what standard deviation is to someone who does not understand any statistics.
- You are going to create a portfolio of two different stocks (50 percent of each in the portfolio). Why can’t you usually take the weighted average of the two individual stock’s standard deviations to calculate the portfolio risk?
- Why does the average 2-stock portfolio give you the same expected return as the average 1-stock portfolio?
- Why does the average 2-stock portfolio give you lower risk than the average 1-stock portfolio? (don’t use coin flip example in your answer)
- Use the coin flip example to show why diversification lowers risk without sacrificing expected return.
- Why are there diminishing returns to diversification? That is, as you add more stocks, the marginal benefits go down. Why?
- How do we calculate beta of McDonald’s? Explain in detail.
- Explain the difference between micro and macro risk.
- Do you receive compensation for bearing micro risk in the CAPM? Explain
- Assume there are 2 portfolios. Portfolio A holds just McDonalds and has a beta of 1.1. Portfolio B holds 100 stocks and has a beta of 1.1.
- Which portfolio has a greater standard deviation? Explain
- Which portfolio has the higher expected return according to CAPM? Explain.
- Draw the scatterplots of the two portfolios relative to the Standard and Poor’s 500.
- Why do we get the same expected return for Portfolio A and B (according to CAPM) even though Portfolio A has more standard deviation?

- What is the shape of the security market line? Explain. Draw the graph.
- What did Fama and French find out about the CAPM? Explain.
- Instead of Beta, what did Fama and French find that worked better than beta? Explain.
- Why does CAPM do so badly at predicting returns?