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CH6-Problem Solutions

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11 views26 pages

CH6-Problem Solutions

Uploaded by

DAMLA DALGIC
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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• a. Coupon rate = 6%, which remains unchanged.

The coupon payments are fixed


at $60 per year.

• b. When the market yield increases, the bond price will fall. The cash flows are
discounted at a higher rate.

• c. At a lower price, the bond’s yield to maturity will be higher. The higher yield
to maturity for the bond is commensurate with the higher yields available in the
rest of the bond market.

• Current yield = coupon rate/bond price


As the coupon rate remains the same and the bond price decreases, the current
yield increases.
• When the bond is selling at a discount, $970 in this case, the yield to
maturity is greater than 8%. We know that if the yield to maturity
were 8%, the bond would sell at par. At a price below par, the yield to
maturity exceeds the coupon rate.
• a. Coupon payment = 0.08  $1,000 = $80
Current yield = $80/bond price = 0.06
Therefore: Bond price = $80/0.06 = $1,333.33

• b. Since the bond is selling at a premium, the YTM must be below the
coupon rate of 8%.
• a. Current yield = coupon/price = $80/$1,100 = 0.0727 = 7.27%

• b. To compute the yield to maturity, use trial and error to solve for
r in the following equation:

Using a financial calculator, compute the yield to maturity by entering


n = 8, PV = ()1,100, FV = 1,000, PMT = 80; compute i = 6.3662%.
• c. To compute the yield to maturity, use trial and error to solve for r in
the following equation:

Using a financial calculator, compute the yield to maturity by entering


n = 16, PV = ()1,100, FV = 1,000, PMT = 40; compute i = 3.1922%.
YTM = 3.1922 × 2 = 6.38%
• a. Bond 1:

• Using a financial calculator:


Year 1: PMT = 80, FV = 1,000, i = 10%, n = 10; compute PV0 = $877.11
Year 2:PMT = 80, FV = 1,000, i = 10%, n = 9; compute PV1 = $884.82
• Bond 2:

• Using a financial calculator:


Year 1:PMT = 120, FV = 1,000, i = 10%, n = 10; compute PV0 = $1,122.89
Year 2:PMT = 120, FV = 1,000, i = 10%, n = 9; compute PV1 = $1,115.18

• b. Both bonds provide the same rate of return.


• a. To compute the yield to maturity, use trial and error to solve for r
in the following equation:

Using a financial calculator, compute the yield to maturity by entering


n = 30, PV = ()900, FV = 1,000, PMT = 80; compute i = 8.971%.
• Verify the solution as follows:
• b. Since the bond is selling for face value, the yield to maturity =
8.000%.
• c. To compute the yield to maturity, use trial and error to solve for r in
the following equation:

Using a financial calculator, compute the yield to maturity by entering


n = 30, PV = ()1,100, FV = 1,000, PMT = 80; compute i = 7.180%.
• Verify the solution as follows:
• Solve the equation for C and we get an annual coupon of $80.
• The coupon rate is 80/1000 = 8%.
• a.-f:
Price of Each Bond at Different Yields to Maturity

Maturity of Bond
Yield 4 Years 8 Years 30 Years

7% $1,033.87 $1,059.71 $1,124.09

8% $1,000.00 $1,000.00 $1,000.00

9% $967.60 $944.65 $897.26

• g-h:The table shows that prices of longer-term bonds are more sensitive
to changes in interest rates, regardless of the direction of interest rates.
• a,b,c:

Yield Price A Price B % Diff (8%) A % Diff (8%) B


2% 144.93 324.67 165% 124%
3% 119.68 277.14 119% 91%
4% 100.00 239.00 83% 65%
5% 84.55 208.15 54% 43%
6% 72.33 183.00 32% 26%
7% 62.59 162.35 14% 12%
8% 54.76 145.24 0% 0%
9% 48.41 130.95 -12% -10%
10% 43.22 118.92 -21% -18%
11% 38.93 108.72 -29% -25%
12% 35.36 99.99 -35% -31%
13% 32.35 92.48 -41% -36%
14% 29.80 85.95 -46% -41%
15% 27.62 80.25 -50% -45%
200%

150%

100%

%diff(8%) A
50%
%diff(8%) B

0%
0% 5% 10% 15% 20%
-50%

-100%

• The price of bond A is more sensitive to interest rate changes as


reflected in the steeper curve.
• e. Bond A has a higher effective maturity (higher duration). A bond
that pays a high coupon rate has a lower effective maturity since a
greater proportion of the total return to the investment is received
before maturity. A bond that pays a lower coupon rate has a longer
average time to each payment.
• a. The coupon rate must be 7% because the bonds were issued at face
value with a yield to maturity of 7%. Now the price is:
• b. The investors pay $634.34 for the bond. They expect to receive the
promised coupons plus $800 at maturity. We calculate the yield to
maturity based on these expectations by solving the following
equation for r:

• Using a financial calculator, enter n = 16, PV = ()634.34, FV = 800,


PMT = 35; then compute i = 6.49%.

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