Sam Strother and Shawna Tibbs are vice presidents of Mutual of Seattle Insurance Company and co-directors of the company’s pension fund management division. An important new client, The North-Western Municipal Alliance, has requested that Mutual of Seattle present an investment seminar to the mayors of the represented cities, and Strother and Tibbs, who will make the actual presentation, have asked you to help them by answering the following questions.
1) What are the key features of a bond?
2) What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky?
3) How does one determine the value of any asset whose value is based on expected future cash flows?
4) How is the value of a
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Inflation premium the higher return that investors demand in exchange for investing in a long-term security where inflation has a greater potential to reduce the real return. The inflation premium is the reason that most yield curves trend upward. Thus, a bond with a maturity of 30 years almost always has a higher coupon rate than one with a maturity of 30 days. Investors expect to make a larger nominal return in part to compensate them for the lower real return that is almost inevitable because of the nature of inflation The additional amount a borrower must pay to compensate the lender for assuming default risk. A default premium is generally paid by all companies or borrowers indirectly, through the rate at which they must repay their obligation. A maturity risk premium is essentially the extra amount you can expect to earn on an investment by tying up your money in it for a longer period of time. For instance, the additional revenue you could get from a 10-year bond versus a 1-year bond would have a certain level of maturity risk premium.
8) Define the nominal risk-free rate. What security can be used as an