Question

3. Using the regular Treasury note of Problem 2:

a. What is its price if investors’ required rate of return is 6.0 percent on similar bonds? Treasury notes pay interest semiannually.

b. Erron Corporation wants to issue five-year notes but investors require a credit risk spread of 3 percentage points. What is the anticipated coupon rate on the Erron notes?

the treasuring note of problem 2

2. Judy Johnson is choosing between investing in two Treasury securities that mature in five years and have par values of $1,000. One is a Treasury note paying an annual coupon of 5.06 percent. The other is a TIPS that pays 3 percent interest annually.

a. If inflation remains constant at 2 percent annually over the next five years, what will be Judy’s annual interest income from the TIPS bond? From the Treasury note?

b. How much interest will Judy receive over the five years from the Treasury note? From the TIPS?

c. When each bond matures, what par value will Judy receive from the Treasury note? From the TIPS?

d. After five years, what is Judy’s total income (interest + par) from each bond? Should she use this total as a way of deciding which bond to purchase?

Answer 1

a.

Face value	$1,000
Coupon	5.06% semiannually
Period	Interest Semiannually($)	PV factor@ 3% semi annually	Present Value in $
1	25.3	0.9709	24.56
2	25.3	0.9426	23.85
3	25.3	0.9151	23.15
4	25.3	0.8885	22.48
5	25.3	0.8626	21.82
6	25.3	0.8375	21.19
7	25.3	0.8131	20.57
8	25.3	0.7894	19.97
9	25.3	0.7664	19.39
10	25.3	0.7441	18.83
10	1000	0.7441	744.09
price of similar bonds			959.91

b. Since the investors expected credit risk is 3%, coupon rate should be 3% in excess of actual coupon rate = 8.06%.(5.06+3)