YTM A company has 7 percent coupon bonds on the market with 9 years left to maturity

| March 30, 2017

Question
1. YTM

A company has 7 percent coupon bonds on the market with 9 years left to maturity. Coupons are paid annually. If the bond currently sells for $1,038.50, what is its yield to maturity? What if the current price is only $980.30?

2. Bond Pricing

A company issued 20-year bonds one year ago at a coupon rate of 6.1%. Coupons are semi-annually paid. If YTM on these bonds is 5.3%, what is the current bond value?

What if the coupon is paid annually?

Hint: Use PV function.

3. Nominal vs Real Returns

A. An investment offers a total return of 14% over the coming year. You believe the real return on this investment will be only 10%. What do you believe the inflation rate will be over the next year?

B. If inflation rate in the next year is 3% and if you want the real return of 8%, what is the nominal return that you require from an investment?

Hint: Fisher Effect Equation.

4. Interest Rate Risk

Both Bonds A and B are priced at par since their YTMs are the same as their coupon rate of 7%. What happens to their prices if interest rate in the market rises by 2%? What if the interest rate falls by 2%? Compute the prices in $ and also the percentage change.

Bond A:

Bond B:

Coupon rate

7%

Coupon rate

7%

Settlement date

1/1/2000

Settlement date

1/1/2000

Maturity date

1/1/2003

Maturity date

1/1/2020

Redemption (% of par)

100

Redemption (% of par)

100

# of coupons per year

2

# of coupons per year

2

YTM

7%

5. Zero Coupon Bonds

Your company needs to raise $30 million by issuing 20-year bonds. Assume YTM is 7.5% and you are evaluating two alternatives: A. 7.5% semiannual coupon bond, or B. a zero coupon bond.

Amount needed

$ 30,000,000

Years to maturity

20

Required return = Coupon rate

7.5%

Face value

$ 1,000

Tax rate

35%

(1) How many of coupon bonds would you need to issue to raise the whole amount? How many of zeroes would you need to issue?

(2) At maturity, what will your company’s repayment be if you issue the coupon bond? What if you issue the zeroes?

6. Holding Period Return

You buy a 7% annual coupon bond for $875 today. The bond has 10 years till maturity.

A. What rate of return do you ‘expect’ to earn on your bond investment?

B. Two years from now, the YTM on your bond has declined by 1% due to credit rating improvement or market interest rate changes. If you decide to sell the bond, what price will your bond sell for? What is the holding period return on your investment? Compare this HPR with the YTM from part A.

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