Group 3 / Fixed Income Securities

ASSIGNMENT 2 ANSWERS
Jessy Chen / 008201700002 / Capital Market
Peliska Ginting / 008201700047 / Capital Market
Reuben Raditya / 008201700071 / Capital Market

1. Type of existing risks

A) Market Risk is associated with the fact that changes in interest rates affect the fixed
income securities value oppositely. Thus the investors are need to decide the execution
carefully to avoid losses from this factor

B) Reinvestment Risk is known as the variability in the returns from reinvestment from a
given strategy due to changes in market rates

C) Call Risk is related to the possibility the bonds can be called back by the issuer for re-
financing purpose, leaving the investor an uncertainty of premature call before maturity
date which resulted in possible lower yield. The bonds can also have exposed with
reinvestment risk if the interest obtained got reinvested again.

D) The credit risk of a bond includes the possibility that the issuer will default on its
obligation (default risk), or referring to the fact that the bond’s value will decline and/or
the bond’s price performance will be worse than that of other bonds against which the
investor is compared because either the market requires a higher due to a perceived
increase in the risk that the issuer will default or companies that assign ratings to bonds
will lower a bond’s rating.

E) The yield-curve, or maturity, risk is related to the assumption of the yield movement
deviation from the adjustment from interest rate movement

F) Inflation risk, or purchasing power risk, arises because of the variation in the value of
cash flows from a security due to inflation, as measured in terms of purchasing power.

G) Liquidity risk is the risk that the investor will have to sell a bond below its true value
where the true value is indicated by a recent transaction. The primary measure of
liquidity is the size of the spread between the bid price and the ask price quoted by a
dealer. The wider the bid-ask spread, the greater is the liquidity risk.

H) The risk source of the exchange-rate risk, or currency risk is the fact that exchanging two
different currencies is still posed to the volatility movement possibilities during the
exchange execution time when particular rate is applied each time.
Group 3 / Fixed Income Securities

I) The risk that a change in volatility will adversely affect the price of a security is called
volatility risk. Investor need to aware to the degree of the volatility and the occurrence
frequency to prepare for this kind of risk

J) The possibility of any political or legal actions adversely affecting the value of a security
is known as political or legal risk. In example, sometimes the government can declare
withholding or other additional taxes on a bond or declare a tax-exempt bond taxable. In
addition, a regulatory authority can conclude that a given security is unsuitable for
investment entities that it regulates. These actions can adversely affect the value of the
security.

K) Occasionally, the ability of an issuer to make interest and principal payments is seriously
and unexpectedly changed by a natural or industrial accident or a takeover or corporate
restructuring, which these kind of risks are referred to as event risk.

L) The possibility of adverse differential movement of specific sectors of the market is

called sector risk. Examples include discount versus premium coupon bonds, industrial
versus utility bonds, and corporate versus mortgage-backed bonds, to which the markets
respond to these kind of risk factors.

2. Given the questions:

a. Compute the price of a coupon bond with 10 years to maturity and a par value of
$1,000 if the required yield is 8%. The present value of the coupon is?
b. Compute the price of a coupon bond with 15 years to maturity and a par value of
$1,800 if the required yield is 12%. The present value of the coupon is?
c. Compute the price of a coupon bond with 20 years to maturity and a par value of
$2,000 if the required yield is 9%. The present value of the coupon is?
1
Answer: 1−(
2,191
)
= $50 [ ]
0.04
a. Known: c = $50
1−0,456
M = $1,000 = $50 [ ]
0.04

n = 10 x 2 = 20 = $50[13.59]

i = 8% = 0.08/2 = 0.04 = $679.51

Asked: Price = …? PV = …? PV
1
= $1,000[(1+0.04)20 ]
1
1−( )
(1+0.04)20 = $1,000[0.45638]
Answer: Price = $50 [ ]
0.04

=$456.38
Group 3 / Fixed Income Securities

b. Known: c = $50 c. Known: c =$50

M = $1,800 M = $2,000

n = 15 x 2 = 30 n = 20 x 2 = 40

i = 12% = 0.12/2 = 0.06 i = 9% = 0.09/2 = 0.045

Asked: Price = …? PV = …? Asked: Price = …? PV = …?

1 1
1−( ) 1−( )
(1+0.06)30 (1+0.045)40
Answer: Price = $50 [ ] Answer: Price = $50 [ ]
0.06 0.045

1 1
1−( ) 1−( )
5,743 5,81
= $50 [ ] = $50 [ ]
0.06 0.045

1−0,174 1−0,172
= $50 [ ] = $50 [ ]
0.06 0.045

= $50[13.76] = $50[18.4]

= $688,241 = $920

1 1
PV = $1,800[(1+0.06)30 ] PV = $2,000[(1+0.045)40 ]

1 1
= $1,800[(1.06)30 ] = $2,000[(1.045)40 ]

1 1
= $1,800[5.743] = $2,000[5.816]

= $1,800[0.1741] = $2,000[0.1719]

=$313,398 =$343.85

3. Given the questions:

a. The price of a zero-coupon bond that matures in 10 years and has a maturity value of $1,510
if the required yield is 8.6% is?

b. The price of a zero-coupon bond that matures in 5 years and has a maturity value of $2,010
if the required yield is 10.8% is?
Group 3 / Fixed Income Securities

a. Equal to present value of $1,510, 20 b. Equal to present value of 2,010, 10

periods from now discounted at 4.3% periods from now discounted at 5.4%

1 1
Answer: $1,510[(1+0.043)20 ] Answer: $2,010[(1+0.054)10 ]

1 1
= $1,510[(1.043)20 ] = $2,010[(1.054)10 ]

= $1,510[0.43] = $2,010[0.591]

= $650.56 = $1187.92

4. Given the questions

a. Explain the relationship among coupon rate, required yield and price

 When the coupon rate equals the required rate, the price equals the par value
 When the price equals the par value, the coupon rate equals the required yield
 When the coupon rate is less than the required yield, the price is less than the par
value
 When the price is less than the par value, the coupon rate is less than the required
yield.
 When the coupon rate is greater than the required yield, the price is greater than the
par value
 When the price is greater than the par value, the coupon rate is greater than the
required yield

b. Explain the reasons for the change in the price of a bond

 A change in the level of interest rates in the economy

 A change in the price of the bond selling at a price other than par as it moves towards
maturity without any change in the required yield
 For non-Treasury bonds, a change in the required yield due to changes in the spread
to Treasuries
 A change in the perceived credit quality of the issuer
 For bonds with embedded options, such as Call-able bonds, Put-able bonds, and
Convertible Bonds. The price of the bonds will change as the factors that affect the
value of the embedded options change.

c. The cash flow of an option-free bond consists of what?

 Periodic coupon interest payments to the maturity date

 The par or maturity value at maturity