Question no 1:-

Answer:-

Interest Rate Risk

We ask our friend about interest Rate Risk. Interest rate risk is the probability of a
decline in the value of an asset resulting from unexpected fluctuations in interest rates.
Interest rate risk indirectly affects many investments, but it directly affects the value of
bonds. Bondholders, above all investors, carefully monitor interest rates. So we ask our
friend to think about that before investing money in bonds.

Inflation Rate Risk

Inflation Risk commonly refers to the situation in which the prices of goods and services
increase more than expected or inversely such situation results in the same amount of
money resulting in less purchasing power. Inflation Risk is also known as Purchasing
Power Risk. An example of Inflation Risk when the expected inflation increases, it
increases the Nominal rates (Nominal Rate is simple Real Rate plus Inflation) and
thereby decreasing the price of Fixed Income Securities. The rationale for such a
behavior is that bonds pay fixed coupon and an increasing price level decreases the
number of real goods and services that such Bond coupon payments will purchase. So
we ask our friend to think about that before investing money in bonds.

Market Risk
Market risk is the possibility of an investor experiencing losses due to factors that affect the
overall performance of the financial markets in which he or she is involved. This can be
contrasted with unsystematic risk, which is unique to a specific company or industry. Also
known as “nonsystematic risk,” "specific risk," "diversifiable risk" or "residual risk," in the
context of an investment portfolio, unsystematic risk can be reduced through divergence.

Question No 2:-

Solution:-

Annual Coupon rate: 6%

Face Value: RS 100/-

Years to Maturity Yield to Maturity Current Price
3 4% 99.22
3 6% 88.99
5 7% 75.58
Calculations:

Formula:

Price = Coupon Payment/(1+i)n + Face Value / (1+i)n

=6/(1+4%)3 + 100/(1+4%)3

=6/(1+0.04)3 + 100/(1+0.04)3

=6 / (1.04)3 + 100/(1+0.04)3

=6/1.124 + 100 / (1.04)3

=6/1.124 + 100 / 1.124

=5.33 + 88.89

=94.22

Price = Coupon payment / (1+i)n + Face Value / (1 + i)n

=6/(1+6%)3 + 100/(1+6%)3

=6/(1+0.06)3 + 100/(1+0.06)3

=6 / (1.06)3 + 100/(1+0.06)3

=6/1.191 + 100 / 1.191

=5.03 + 88.96

= 88.99

Price = Coupon payment / (1+i)n + Face Value / (1 + i)n

=6/(1+7%)5 + 100/(1+7%)5

=6/(1+0.07)5 + 100/(1+0.07)5

=6 / (1.07)3 + 100/(1.07)3

=6/1.40 + 100 / 1.40

=4.278 + 71.298

= 75.577