1. Let’s say you are planning for a big vacation in four years. You estimate this exquisite trip will cost you $12,000. You plan on investing in bonds to ensure you have the cash on hand when it is time to finance the trip. Say you decided to purchase a 5-year 12% coupon bond that currently yields 8%APR. Its Macaulay Duration is 4.1542 years.
b. What is the price of $1000 in the bond’s face value today?
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c. If the interest remains at 8%APR, what is the time-4-year value of the coupon payments (on $1000 of face value) received in years 0 through 4?
d. If the interest remains at 8%APR, what is the time-4-year value of the remaining bond cash flows (for $1000 of face value)?
e. If the interest remains at 8%APR, what is the time-4-year total value of all expected cash flows per $1000 of face value (consider coupons, interest from reinvestment of coupons, and selling price of the bond)?
f. If the interest remains at 8%APR, what is the time-4-year total value of all expected cash flows per $7544.44 of face value (consider coupons, interest from reinvestment of coupons, and selling price of the bond)?
g. How does the value from part f compare to your trip cost?
h. If tomorrow morning the interest rate on the bond shifts to 10%APR, what is the time-4-year value of the coupon payments received in years 0 through 4?
i. If tomorrow morning the interest rate on the bond shifts to 10%APR, what is the time-4-year value of the remaining bond cash flows?
j. If tomorrow morning the interest rate on the bond shifts to 10%APR, what is the time-4-year total value of all expected cash flows (consider coupons, interest from reinvestment of coupons, and selling price of the bond)?
k. If tomorrow morning the interest rate on the bond shifts to 10%APR, what is the time-4-year total value of all expected cash flows per $7544.44 of face value (consider coupons, interest from reinvestment of coupons, and selling price of the bond)?
l. How well did this investment strategy manage your interest rate risk?