00THE FORMULA FOR THE PRICE AT EACH NODE IS

100.00

The formula for the price at each node is:

Price = min{(prob × (P

_up

+ coupon/2) + prob × (P

_down

+ coupon/2)) / (1 + rate/2), call price}.

Up Node at t = 0.5: min{(0.5 × (100 + 2.5) + 0.5 × (100 + 2.5)) / (1 + 0.0759/2), 99} = 98.75.

Down Node at t = 0.5: min{(0.5 × (100 + 2.5) + 0.5 × (100 + 2.5)) / (1 + 0.0533/2), 99} = 99.00.

Node at t = 0.0: min{(0.5 × (98.75 + 2.5) + 0.5 × (99 + 2.5)) / (1 + 0.0635/2), 99} = 98.26.

Question #37 of 88

Question ID: 463858

Suppose that the stock price of a common stock increases by 10%. Which of the following is most accurate for the price of the recently

issued convertible bond? The value of the convertible bond will:

ᅚ

A)

increase by less than 10%.

ᅞ

B)

remain unchanged.

ᅞ

C)

increase by 10%.

Explanation

When the underlying stock price rises, the convertible bond will underperform because of the conversion premium. However, buying

convertible bonds in lieu of stocks limits downside risk. The price floor set by the straight bond value causes this downside protection.

Question #38 of 88

Question ID: 463810

Patrick Wall is a new associate at a large international financial institution. His boss, C.D. Johnson, is responsible for

familiarizing Wall with the basics of fixed income investing. Johnson asks Wall to evaluate the two otherwise identical bonds

shown in Table 1. The callable bond is callable at 100 and exercisable on the coupon dates only.

Wall is told to evaluate the bonds with respect to duration and convexity when interest rates decline by 50 basis points at all

maturities over the next six months.

Johnson supplies Wall with the requisite interest rate tree shown in Figure 1. Johnson explains to Wall that the prices of the

bonds in Table 1 were computed using the interest rate lattice. Johnson instructs Wall to try and replicate the information in

Table 1 and use his analysis to derive an investment decision for his portfolio.

Table 1Bond DescriptionsNon-callable Bond Callable BondPrice $100.83 $98.79Time to Maturity (years) 5 5Time to First Call Date -- 0Annual Coupon $6.25 $6.25Interest Payment Semi-annual Semi-annualYield to Maturity 6.0547% 6.5366%Price Value per Basis Point 428.0360 --

Figure 1