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Treasury Bonds and Notes

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1) A six-month $10,000 Treasury bill is selling for $9,844. What is the annual yield according to the discount method? Does this yield understate or over-state the true annual yield? Explain

2) What is the current taxable equivalent yield for an individual in the 35% federal income tax bracket for intermediate bonds (10 or fewer yrs to maturity) and long-term bonds (30 yrs to maturity)?

3) The federal government issues two four-yr notes. The first is a traditional type of debt instrument that pays 6% annually ($60 per $1,000 note). The second pays a real yield of 3 % with the amount of interest being adjusted with changes in the CPI. The CPI was 100 when the notes were initially issued.

a) What is the annual amount of interest paid each year on each security if the CPI is as follows?
Yr CPI
1 102
2 96
3 103
4 110

b) What is the amount of principal repaid at maturity by each note?
c) Using the dollar-weighted return, what is the nominal, annual rate of return on each security?
d) Based on the answer to part (c) which alternative produced the higher return and why?

4) This problem illustrates "riding the yield curve", The U.S. Treasury issue a 10-yr, zero coupon bond.

a) What will be the original issue price if comparable yields are 6%? (Assume annual compounding.)

b) What will be the price of this zero coupon bond after 3, 6, and 9 yrs have passed if the comparable yield remains 6%? What are the annualized returns the investor earns if the bond is sold after 3, 6, or nine yrs?

c) When the bond was issued, the structure of yields was as follows:
Yrs to Maturity Yield
1 3
4 4
7 5
10 6

What will be the price of the bond after 3, 6, and 9 yrs have passed if this structure of yields does not change? What is the annualized return the investor earns if the bond is sold after 3, 6, or nine yrs?

d) If the structure of yields does change to the following:
Yrs to maturity Yield
1 2
4 3
7 4
10 5

What will be the price of the bond after 3, 6, and nine yrs have passed?
What is the annualized return the investor earns of the bond is sold after 3, 6, or 9 yrs?

e) If the structure of yields changes to the following?
Yrs to Maturity Yield
1 4
4 5
7 6
10 7

What will be the price of the bond after 3, 6, and nine yrs have passed?
What is the annualized return the investor earns of the bond is sold after 3, 6, or 9 yrs?
f) Why are the annualized returns different in part b-e?

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