"Fixed Income Investments":Equivalent yield
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Questions 1:
A 90-day commercial paper issue is quoted at a discount rate of 4.75% for a 360-day year. The bond equivalent yield for this instrument is closest to:
A. 4.87%.
B. 4.75%.
C. 4.81%
Questions 2:
In a rising interest rate environment, the effective duration of a putable bond relative to an otherwise identical non-putable bond, will most likely be:
A. higher.
B. lower.
C. the same.
The price of the commercial paper per 100 of par value is: where PV and FV are the price and face value of the money market instrument, Days is the number of days between settlement and maturity, Year is number of days in the year, and DR is the discount rate stated as an annual percentage.
When interest rates are rising, the put option becomes more valuable to the investor. The ability to sell the bond at par value limits the price depreciation as rates rise. So, the presence of an embedded put option reduces the sensitivity of the bond price to changes in interest rates, resulting in a lower effective duration.
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