Inflation and Bond Value-

**QUESTIONS: 5-4, 5-5**

5-4.

If you buy a callable bond and interest rates decline, will the value of your bond rise by as much as it would have risen if the bond had not been callable? Explain.

5-5.

A sinking fund can be set up in one of two ways. Discuss the advantages and disadvantages of each procedure from the viewpoint of both the firm and its bondholders.

**PROBLEMS: 5-6, 5-12, 5-20**

5-6.

The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-year Treasury security yields 6.3%. What is the maturity risk premium for the 2-year security?

5-12.

A 10-year, 12% semiannual coupon bond with a par value of $1,000 may be called in

4 years at a call price of $1,060. The bond sells for $1,100. (Assume that the bond has just been issued.)

- What is the bond’s yield to maturity?
- What is the bond’s current yield?
- What is the bond’s capital gain or loss yield?
- What is the bond’s yield to call?

5-20.

Because of a recession, the inflation rate expected for the coming year is only 3%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3%. Assume that the real risk-free rate is r* = 2% for all maturities and that there are no maturity premiums. If 3-year Treasury notes yield 2 percentage points more than 1-year notes, what inflation rate is expected after Year 1?

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