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In the middle of the 1990's, a portfolio manager bought Collateralized Mortgage Obligation bonds created from FNMA mortgage pass-through bonds. The CMO bonds had a par value of $1000 per bond, but the coupon rate was variable. The coupon rate each year would rise by 1% for each 1% decline in the interest rate of home mortgages, and fall by 1% for each 1% increase in home mortgage interest rates. This is called an inverse floater. Explain why an active portfolio manager would buy such a strange bond?

16.Consider two bonds, A and B.  Both bonds presently are selling at their par value of $1,000.  Each pays interest of $120 annually.  Bond A will mature in 5 years while bond B will mature in 6 years.  If the yields to maturity on the two bonds change from 12% to 10%,____________.

A)both bonds will increase in value, but bond A will increase more than bond B

B)both bonds will increase in value, but bond B will increase more than bond A

C)both bonds will decrease in value, but bond A will decrease more than bond B

D)both bonds will decrease in value, but bond B will decrease more than bond A

E)none of the above

17.A coupon bond pays annual interest, has a par value of  $1,000, matures in 4 years, has a coupon rate of 10%, and has a yield to maturity of 12%.  The current yield on this bond is ___________.

A)9.39%

B)10.00%

C)10.65%

D)12.00%

E)none of the above

18.A zero-coupon bond has a yield to maturity of 9% and a par value of $1,000.  If the bond matures in 8 years, the bond should sell for a price of _______ today.

A)422.41

B)$501.87

C)$513.16

D)$483.49

E)none of the above

19.You have just purchased a 10-year zero-coupon bond with a yield to maturity of 10% and a par value of $1,000.  What would your rate of return at the end of the year be if you sell the bond?  Assume the yield to maturity on the bond is 11% at the time you sell.

A)10.00%

B)20.42%

C)13.8%

D)1.4%

E)none of the above

20.A coupon bond is reported as having an ask price of 113% of the $1,000 par value in the Wall Street Journal.  If the last

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