Chapter 10: Bond Return and Valuation Q. 6.

Find out the yield to maturity on a 8 per cent 5 year bond selling at Rs 105? Solution: C + ( P or D/years to maturity) Yield to Maturity = ( P0 + F )/2

100 105 8+ 5 100 = 100 + 105 2

=

8 + ( 1) 7 100 = 100 102.5 102.5

YTM = 6.82.

Q. 7. (a)

(b)

Determine the present value of the bond with a face value of Rs 1,000, coupon rate of Rs 90, a maturity period of 10 years for the expected yield to maturity of 10 per cent. In N is equal to 7 years in the above example, determine the present value of the bond. Discuss the effect of the maturity period on the value of the bond.

Solution:
Face Value = Rs 1,000 Coupon Rate = Rs 90 Maturity Period = 10 years YTM = 10 % Present value = C(PVI FA k,n) + F (PVIF k,n) = 90 (6.145) + 1000 (0.386) = 553.05 + 386 = Rs 939.05 If N = 7 years Present Value = 90 (4.868) + 1,000 (0.513) = 438.12 + 513

P0 = Rs 951.12
With the increase in maturity period, the discount rate has increased, the discount is more (1000 939.05 = Rs 60.95) in 10 year bond than 7 year bond (1000 951.12 = Rs 49.88)

Q. 8. Anns bond portfolio manager advises her to buy a 7 years, Rs 5,000 face value bond that gives 8 per cent annual coupon payments. The appropriate discount rate is 9 per cent. The bond is currently selling at Rs 4,700. Should Ann adhere to the managers advice? Solution: N = 7 years, C = 8 %,
Discount rate = 9 % Market price = Rs 4700, Face value = Rs 5,000.

P0 = C(PVIFA k,n) + Face value (PVIF k,n)

= 400 (5.033) + 5,000 (0.547) = 2,013.2 + 2,735 = Rs 4,748.2 Rs 4,700 < 4,748 Ann can buy the bond.

Q. 9. Bonds A and B have similar characters except the maturity period. Both the bonds carry 9 per cent coupon rate with the face value of Rs 10,000. The yield to maturity is 9 per cent. If the yield to maturity is to rise to 11 per cent what will be the respective price change in bond A with 7 years to maturity and B with 10 years to maturity? Solution:
A N C YTM Face Value 7 9 per cent 9 per cent 10,000 B 10 9 per cent 9 per cent 10,000

Bond A If YTM = 9 %

P0 = 900 (5.033) + 10,000 (0.547)

= 4527.7 + 5470 = Rs 9999.7 (or) 10,000

If YTM = 11 %

P0 = 900 (4.713) + 10,000 (0.482)

= 4241.7 + 4820 = Rs 9061.7 The P0 declined by Rs 938.3

Bond B If YTM 9 % P0 = 900 (6.418) + 10,000 (0.422)

= 5776.2 + 4220 = Rs 9996.2 If YTM 11 %

P0 = 900 (5.889) + 10,000 (0.352)

= 5300 + 3520

P0 = Rs 8820
The P0 declined by Rs 1176.2

Q. 10. Consider a bond selling at a par value of Rs 1,000 with 7 years to maturity and 8 per cent coupon payment. Calculate the bonds duration. (b) If the yield to maturity increases to 9 per cent, what would be the price change? Solution: (a)
D= Pv (Ct ) t o t =1 P
T

N = 7 years, C = 8 per cent P0 = Rs 1,000

Years 1 2 3 4 5 6 7 Ct 80 80 80 80 80 80 1,080 PVIF (8 per cent) 0.926 0.857 0.794 0.735 0.681 0.630 0.583 Pi Total of PV 74.08 68.56 63.52 58.8 54.48 50.4 629.64 Pi /P0 Yrs 0.074 0.137 0.191 0.235 0.272 0.302 4.407 5.619

D = 5.619
(b) If YTM is 8 per cent, the price will be = C (PVIFA k, n) + Face value (PVIF k, n) = 80 (5.206) + 1,000 (0.583) = 999.48

If the YTM is 9 per cent

P0 = 80 (5.033) + 1,000 (0.547) P0 = 402.64 + 547 = 949.64

If the YTM increases to 9 per cent, the change will be Rs 49.84.

Q. 11. A bond with the face value of Rs 1,000 pays a coupon rate of 9 per cent. The maturity period is 9 years Find out the (a) approximate yield to maturity if the require rate of return is 10% (b) current yield . Solution: Face Value = Rs 1000
C = Rs 90 (i.e., 9 per cent) N = 9 years Discount rate = 10%
Years 1 2 3 4 5 6 7 8 9 Cash flow 90 90 90 90 90 90 90 90 1090 PV@ 10 per cent 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 PV of total cash flow 81.81 74.34 67.59 61.47 55.89 50.76 46.17 42.03 462.16 942.22

The present value P0 is 942.22. There is no premium or discount. The YTM is 10 per cent (a) The approximate YTM = 90 (942.22 + 1000) /2

= 0.093 YTM = 9.3 per cent (b) Current yield =

Annual Coupon Payment Market Price 90 = = 9 per cent 1000

Q. 12. Determine the price of Rs 1,000 zero coupon bond with a YTM of 15 per cent and 10 years to maturity. Solution:
YTM = 15 per cent, Price = =
Face Value (1 + YTM) n

C = 0,

Face value = Rs 1,000

1000 1,000 = = 247.16. 10 4.046 (1 + 0.15)

Q. 13. Determine the yield to maturity if a zero coupon bond with a face value of Rs 1,000 is sold at Rs 300. The maturity period is 10 years Solution: FV = Rs 1,000; N = 10 years
C = 0;
YTM = ?
1/n

Face Value YTM = Bond Value 1,000 = 300

YTM = 12.8.
1/10

1 = 1.128

= 1.128 1 = 0.128

Q. 14. What is the value of Rs 1,000 bond that paying 5 per cent annual coupon rate in semi-annual payments over 5 years until it matures if its yield to maturity is 7 per cent? Solution: FV = 1,000; C = 5 per cent;
P0 = 50 (4.10) + 1,000 (0.713) = 205 + 713 P0 = Rs 918.

Q. 15. Determine Macaulays duration of a bond that has a face value of Rs 1,000 with 10 per cent annual coupon rate and 3 years term to maturity. The bonds yield to maturity is 12 per cent.

Solution:

FV = Rs 1,000

C = 10 per cent N = 3 years

YTM = 12 per cent

Years 1 2 3

Cash flow 100 100 1,100

PVIF 12% 0.893 0.797 0.712

Pv 89.3 79.7 783.2 P0 = 952.2

Pv/P0 0.0938 0.0837 0.8225

Pv/P0 Years 0.0938 0.1674 2.4675 2.7287

Macaulays Duration = 2.7287.