Exam 5: Interest Rate Risk

Use the following information for questions There are two riskless bonds which mature at t = 2.The first is a zero coupon bond that pays a balloon of $ 1,200.The other is a coupon bond with an annual coupon of $100 and a balloon payment of $990.The current yield on a riskless bond that mature in one year is 10%, the annualized yield on a two-year bond is also 10%. -If the interest rate at t = 1 can be 8% or 12%, what is the percentage price change for the zero coupon bond Answer: change for 8%, change for 12%; round to the nearest figure)?

Use the following information for questions There are two riskless bonds which mature at t = 2.The first is a zero coupon bond that pays a balloon of $ 1,200.The other is a coupon bond with an annual coupon of $100 and a balloon payment of $990.The current yield on a riskless bond that mature in one year is 10%, the annualized yield on a two-year bond is also 10%. -What is the duration of each bond Answer: zero coupon, coupon)?

Duration is different from maturity because duration reflects

Use the following information for questions There is a two-period zero coupon bond that will pay $10 million at t = 2.At t = 0, a call option on this bond is selling at $225,000.The holder can exercise the option at t = 1 at a price of $9,250,000.The current yield on a riskless zero coupon bond that matures at t = 1 is 8%.It is known that the yield on one-period bonds at t = 1 will be 6% or 10%.All bonds are identical except in maturity. -Suppose that the payoff to the option holder is $250,000.What is the risk-neutral probability that the interest rate will be 6% round up to the nearest figure?