FM for Actuaries

Bonds and Bond Pricing 207
6. When the term structure is not flat, the basic bond price formula does not
hold. The principle of pricing the bond as the present value of the coupon
and redemption payments still applies, and the present values are evaluated
based on the market term structure.
Exercises
6.1 Bond is classified as a fixed-income security, which is a large class of investment
vehicles including mortgage loan and certificate of deposit (CD).
Explain why it is so.
6.2 Find the price of a 6-year $100 par value bond bearing 8% annual coupon,
redeemable at $103 with a yield of 2%, 3%, ··· , 10% and 11%. Give a rough
sketch of the bond price versus the yield rate. What can you observe?
6.3 State two factors that a rating agency would use to determine the rating of a
bond.
6.4 Which one of the following statements is true?
(a) A zero-coupon bond has no default risk.
(b) A zero-coupon bond has no market risk.
(c) A zero-coupon bond has no liquidity risk.
(d) A zero-coupon bond has no reinvestment risk.
(e) A zero-coupon bond has no inflation risk.
6.5 Which of the following statement(s) is/are true?
(a) Junk bonds have higher yield than government bonds.
(b) Junk bonds are too risky for individual investors.
(c) Junk bonds are issued by companies with deteriorating credit rating.
6.6 Construct a bond amortization schedule for a $100 par value 2-year bond
with 7% coupons paid semiannually, redeemable at par and bought to yield
4% per annum.