Note: On all problems, you may assume $1,000 par value for the bonds.
1. A 4.75% coupon municipal bond has 22 years left to maturity and can be called in 7 years. Its current price is quoted at 104.45. The bond pays semi-annual coupons. The call premium is one year of coupon payments. Compute the bond’s current yield, yield-to-maturity, yield-to-call, and taxable equivalent yield, assuming a tax rate of 28%. Explain why the current yield is not a complete measure of the true rate of return you would earn on a bond.
2. If you buy a 6.5% coupon (assume semi-annual payments), 25-year bond today when current market rates are 5.4%, and you own this bond for 5 years and sell it when current market rates are 7%, what will be the gain or loss in the price of this bond over the five-year period in both dollar and percentage terms?
3. Consider two bonds, both with 8% coupon rates (assume annual coupon payments) one with 10 years to maturity and the other with 20 years to maturity. Assume that current market rates of interest are 8%. Calculate the difference in the change of the price of the two bonds if interest rates immediately decrease to 7%.