Problem
I. Kay Corporation's 5-year bonds yield 6.20%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay's bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) × 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Kay's bonds?
II. Moerdyk Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a par value of $1,000. The going annual interest rate (rd) is 6.20%. What is the bond's price?
III. Taussig Corp.'s bonds currently sell for $1,150. They have a 6.35% annual coupon rate and a 20-year maturity, but they can be called in 5 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Calculate the yield to maturity (YTM= rD) and the yield to call (YTC). Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds?
IV. Miller Corporation has a premium bond making semiannual payments. The bond pays an 8 percent coupon, has a YTM of 6 percent, and has 13 years to maturity. The Modigliani Company has a discount bond making semiannual payments. The bond pays a 6 percent coupon and has a YTM of 8 percent, and also has a 13 years maturity. Assume a face value of $1,000 for both bonds.
i. If interest rates remain unchanged, what do you expect the price of these bonds to be 1 year from now? One day before maturity? [0.5 points]
ii. Suppose the YTM increases 1 percent for each of the bonds (7 percent and 9 percent, respectively). Calculate the Holding Period Yield of the one-year investment for each of the bonds (from today to one year from today).