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Chapter 06

Inputs are in Blue


Answers are in Red
NOTE: Some functions used in these spreadsheets may require that
the "Analysis ToolPak" or "Solver Add-In" be installed in Excel.
To install these, click on the Office button
then "Excel Options," "Add-Ins" and select
"Go." Check "Analysis ToolPak" and
"Solver Add-In," then click "OK."

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ts may require that


alled in Excel.

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Quiz 3
A bond with face value $1,000 has a current yield of 6% and a coupon rate of 8%.
What is the bonds price?
Face value
Current Yield
Coupon Rate

$1,000.00
6%
8%

Solution:
Bond price

$1,333.33

note: current yield =coupon payment/bond price

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nt/bond price

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Quiz 4
A 6-year Circular File bond pays interest of $80 annually and sells for $950.
What are its coupon rate and yield to maturity?
Time
Interest
Price

6.00 years
80.00
950.00

Solution:
Coupon rate

8.00%

Using a financial calculator:


Yield to maturity

9.119%

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Quiz 5
A 6-year Circular File bond pays interest of $80 annually and sells for $950.
If Circular File wants to issue a new 6-year bond at face value, what coupon rate must the bond offer?
Time
Interest
Price

6.00 years
80.00
950.00

Solution:
In order for the bond to sell at par, the coupon rate must equal the yield to maturity.
Using a financial calculator:
Yield to maturity
9.119%
Hence the coupon rate must be

9.119%

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Quiz 6
A bond has 8 years until maturity, a coupon rate of 8%, and sells for $1,100.
a. What is the current yield on the bond?
b. What is the yield to maturity?
Time
Coupon rate
Price

8.00 years
8%
1,100.00

Solution:
a.

Current yield

b.

Using a financial calculator:


Yield to maturity

7.27%

recall: current yield=coupon payment/bond price


put the kursor on the answer, klick on f

6.3662%

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oupon payment/bond price


answer, klick on f x to see the functionargument =Rnta (perioder; betalning; nuvrde; slutvrde; typ)

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Quiz 7
General Matters outstanding bond issue has a coupon rate of 10%, and it sells at
a yield to maturity of 9.25%. The firm wishes to issue additional bonds to the public at face
value. What coupon rate must the new bonds offer in order to sell at face value?
Coupon rate
YTM

10%
9.25%

Solution:
Coupon rate on the new bonds

9.25%

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Quiz 8
Refer to Table 6.1 (below). What is the current yield of the 8.75% 2020 maturity
bond? Why is this more than its yield to maturity?
Table 6.1
Maturity

Coupon

2012 May 15
2013 May 15
2014 May 15
2020 May 15
2025 Aug 15
2030 May 15
2040 May 15

1.375
3.625
4.75
8.75
6.875
6.25
4.375

Coupon Rate
Asked Price

Bid Price Asked Price Asked Yield, %


101:05
106:31
111:22
144:17
133:07
128:25
100:28

8.75%
144.00

101:06
107:01
111:23
144:19
133:11
128:27
100:29

0.78
1.23
1.7
3.44
3.94
4.12
4.32

19.00

Solution:
Current yield

6.05%

The current yield exceeds the yield to maturity on the bond because the bond is selling at a
premium. At maturity the holder of the bond will receive only the $1,000 face value, reducing
the total return on investment

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Practice Problem 9
One bond has a coupon rate of 8%, another a coupon rate of 12%. Both bonds have 10-year
maturities and sell at a yield to maturity of 10%. If their yields to maturity next year are still 10%,
what is the rate of return on each bond? Does the higher coupon bond give a higher rate of return?
Coupon rate - bond 1
Coupon rate - bond 2
Maturity
YTM
YTM next year

8.00%
12.00%
10.00 years
10.00%
10.00%

Solution:
Using a financial calculator:
Bond 1:
Rate of return

10.00%

10.00%

Bond 2:
Rate of return

Both bonds provide the same rate of return.

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Practice Problem 10
A bond has 8 years until maturity, a coupon rate of 8%, and sells for $1,100.
a. If this bond has a yield to maturity of 8% 1 year from now, what will its price be?
b. What will be the rate of return on the bond?
c. If the inflation rate during the year is 3%, what is the real rate of return on the bond?
Time
Coupon rate
Price
YTM
Inflation

8.00 years
8%
1,100.00
8%
3%

Solution:
a.

Bond Price

b.

c.

$1,000.00

Bond Price
Rate of return

$1,000.00
-1.82%

Rate of return
Real return

-1.82%
-4.68%

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Practice Problem 11
A General Electric bond carries a coupon rate of 8%, has 9 years until maturity, and sells at a
yield to maturity of 7%.
a. What interest payments do bondholders receive each year?
b. At what price does the bond sell? (Assume annual interest payments.)
c. What will happen to the bond price if the yield to maturity falls to 6%?
Face value
Time
Coupon rate
YTM
YTM falls to

$1,000.00
9.00 years
8%
7%
6%

Solution:
a.

Annual interest payments

b.

Annual interest payments


Bond price

80.00
$1,065.15

Annual interest payments


Bond price if YTM falls to 6%

80.00
$1,136.03

c.

80.00

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Practice Problem 12
A 30-year maturity bond with face value of $1,000 makes annual coupon payments and has a
coupon rate of 8%. What is the bonds yield to maturity if the bond is selling for
a.

900.00 ?

b. $ 1,000.00 ?
c.

$ 1,100.00 ?
Face value
Time
Coupon rate

$ 1,000.00
30.00 years
8%

Solution:
Using a financial calculator:
a.

Yield to maturity

8.971%

b.

Yield to maturity

8.000%

c.

Yield to maturity

7.180%

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Practice Problem 13
A 30-year maturity bond with face value of $1,000 makes semi-annual coupon payments
and has a coupon rate of 8%. What is the bonds yield to maturity if the bond is selling for
a.

900.00 ?

b. $ 1,000.00 ?
c.

$ 1,100.00 ?
Face value
Time
Coupon rate

$ 1,000.00
30.00 years
8%

Solution:
Using a financial calculator:
a.

Yield to maturity

8.966%

b.

Yield to maturity

8.000%

c.

Yield to maturity

7.184%

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Practice Problem 14
Fill in the table below for the following zero-coupon bonds. The face value of each bond
is $1,000.
Price
$300.00
$300.00

Maturity
(years)
30.00

10.00

Face value

Yield to
Maturity

8%
10%
$ 1,000.00

Solution:
Price = $1,000/(1 + y)maturity
Price
$300.00
$300.00
$385.54

Maturity
(years)
30.00
15.64
10.00

Yield to
Maturity
4.095%
8.000%
10.000%

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Practice Problem 15
Perpetual Life Corp. has issued consol bonds with coupon payments of $60. (Consols pay interest
forever and never mature. They are perpetuities.) If the required rate of return on these bonds at the
time they were issued was 6%, at what price were they sold to the public? If the required return
today is 10%, at what price do the consols sell?
Coupon Payments
Required rate of return
at the time of issue
Current required rate of return

60.00
6%
10%

Solution:
PV of perpetuity = coupon payment/rate of return
Present value

$ 1,000.00

If the required rate of return is 10%, the bond sells for:


Present value

600.00

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bonds at the

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Practice Problem 16
Sure Tea Co. has issued 9% annual coupon bonds that are now selling at a yield to maturity of
10% and current yield of 9.8375%. What is the remaining maturity of these bonds?
Face value
Time
Coupon rate
Yield to maturity
Current yield

$ 1,000.00
30.00 years
9%
10%
9.8375%

Solution:
Using a financial calculator:
Remaining maturity

20.00 years

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Practice Problem 17
Large Industries bonds sell for $1,065.15. The bond life is 9 years, and the yield to maturity is
7%. What must be the coupon rate on the bonds?
Face value
Bond price
Time
Yield to maturity

$1,000.00
$1,065.15
9.00 years
7%

Solution:
Using a financial calculator:
Coupon rate

8.00%

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Practice Problem 18
a. Several years ago, Castles in the Sand, Inc., issued bonds at face value at a yield to maturity
of 7%. Now, with 8 years left until the maturity of the bonds, the company has run into hard
times and the yield to maturity on the bonds has increased to 15%. What has happened to the
price of the bond?
b. Suppose that investors believe that Castles can make good on the promised coupon payments,
but that the company will go bankrupt when the bond matures and the principal comes due.
The expectation is that investors will receive only 80% of face value at maturity. If they buy the
bond today, what yield to maturity do they expect to receive?
Face value
Yield to maturity
Years left
Yield to maturity increased to
Face value received by the investors

$1,000.00
7%
8.00
15%
80%

Solution:
a.

Price of bond

b.

Price of bond
Using a financial calculator:
Yield to maturity

$ 641.01
$ 641.01

12.87%

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Practice Problem 19
You buy an 8% coupon, 10-year maturity bond for $980. A year later, the bond price is $1,200.
a. What is the new yield to maturity on the bond?
b. What is your rate of return over the year?
Face value
Coupon rate
Time
Bond price
Bond price a year later

$ 1,000.00
8%
10.00 years
980.00
1,200.00

Solution:
Using a financial calculator:
a.

Yield to maturity

5.165%

b.

Rate of return

30.61%

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Practice Problem 20
You buy an 8% coupon, 20-year maturity bond when its yield to maturity is 9%. A year later, the
yield to maturity is 10%. What is your rate of return over the year?
Face value
$1,000.00
Coupon rate
8%
Time
20.00 years
Yield to maturity
9%
Yield to maturity next y
10%
Solution:
Using a financial calculator:
Rate of return

bond price at t0
908.71 kr
bond price at t1
832.70 kr
total return on investment on bond:
(coupon payment + P1-P0)/ P0
0.4388%

0.44%

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ment on bond:

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Practice Problem 21
Consider three bonds with 8% coupon rates, all selling at face value. The short-term bond has a
maturity of 4 years, the intermediate-term bond has maturity 8 years, and the long-term bond has
maturity 30 years.
a. What will happen to the price of each bond if their yields increase to 9%?
b. What will happen to the price of each bond if their yields decrease to 7%?
Face value
Coupon rate
Short term bond maturity
Intermediate-term bond maturity
Long-term bond maturity
Yield (a)
Yield (b)

$ 1,000.00
8%
4.00 years
8.00 years
30.00 years
9%
7%

Solution:
a., b.
Price of Each Bond at Different Yields to
Maturity
Maturity of Bond
Yield
7%
8%
9%

4 Years
$ 1,033.87
$ 1,000.00
$ 967.60

8 Years
$ 1,059.71
$ 1,000.00
$ 944.65

30 Years
$ 1,124.09
$ 1,000.00
$ 897.26

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Practice Problem 22
A 2-year maturity bond with face value of $1,000 makes annual coupon payments of $80 and
is selling at face value. What will be the rate of return on the bond if its yield to maturity at
the end of the year is
a.

6% ?

b.

8% ?

c.

10% ?
Face value
Annual coupon
Time

$1,000.00
$ 80.00
2.00 years

Solution:
a.

Rate of return

9.89%

b.

Rate of return

8.00%

c.

Rate of return

6.18%

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Practice Problem 23
A bond that pays coupons annually is issued with a coupon rate of 4%, maturity of 30 years,
and a yield to maturity of 7%. What rate of return will be earned by an investor who purchases
the bond and holds it for 1 year if the bonds yield to maturity at the end of the year is 8%?
Face value
Coupon rate
Time
Yield to maturity
Yield to maturity by end of 1st year

$ 1,000.00
4%
30.00 years
7%
8%

Solution:
Rate of return

-5.43%

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Practice Problem 24
A bonds credit rating provides a guide to its risk. Long-term bonds rated Aa currently offer yields to
maturity of 7.5%. A-rated bonds sell at yields of 7.8%. If a 10-year bond with a coupon rate of 7% is
downgraded by Moodys from Aa to A rating, what is the likely effect on the bond price?
Face value
Coupon rate
Time
Current yield to maturity
Yield of A rated bonds

$ 1,000.00
7%
10.00 years
7.5%
8%

Solution:
The bonds yield to maturity will increase from 7.5% to 7.8% when the perceived default risk
Increases.
The bond price will fall:
Initial price

$965.68

New price

$945.83

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Practice Problem 25
Suppose that you buy a 1-year maturity bond for $1,000 that will pay you back $1,000 plus a
coupon payment of $70 at the end of the year. What real rate of return will you earn if the inflation
rate is
a.

2% ?

b.

4% ?

c.

6% ?

d.

8% ?
Face value
Annual coupon
Time

$ 1,000.00
$
70.00
1.00 year

Solution:
a.

Real rate of return

4.902%

b.

Real rate of return

2.885%

c.

Real rate of return

0.9434%

d.

Real rate of return

-0.926%

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Practice Problem 26
Suppose that you buy a 1-year maturity bond for $1,000 that will pay you back $1,000 plus a
coupon payment of $70 at the end of the year and the inflation rate is
a.

2% ?

b.

4% ?

c.

6% ?

d.

8% ?

Now suppose that the bond is a TIPS (inflation-indexed) bond with a coupon rate of 4%.
What will the cash flow provided by the bond be for each of the four inflation rates? What will be
the real and nominal rates of return on the bond in each scenario?
Face value
Time
Coupon rate

$ 1,000.00
1.00 year
4%

Solution:
The principal value of the bond will increase by the inflation rate, and since the coupon
is 4% of the principal, the coupon will also increase along with the general level of
prices. The total cash flow provided by the bond will be:
1,000 x (1 + inflation rate) + coupon rate x 1,000 x (1 + inflation rate)
Since the bond is purchased for face value, or $1,000, total dollar nominal return is
therefore the increase in the principal due to the inflation indexing, plus coupon income:
Income = ($1,000 x inflation rate) + [coupon rate x $1,000 x (1 + inflation rate)]
Finally: Nominal rate of return = income/$1,000
a.

b.

c.

d.

Nominal rate of return

6.080%

Real rate of return

4.00%

Nominal rate of return

8.160%

Real rate of return

4.00%

Nominal rate of return

10.240%

Real rate of return

4.00%

Nominal rate of return

12.320%

Real rate of return

4.00%

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Practice Problem 27
Suppose that you buy a 1-year maturity bond for $1,000 that will pay you back $1,000 plus a
coupon payment of $70 at the end of the year and the inflation rate is
a. 2% ?
b. 4% ?
c. 6% ?
d. 8% ?
Now suppose the TIPS bond in the previous problem is a 2-year maturity bond.
What will be the bondholders cash flows in each year in each of the inflation scenarios?
Face value
Time
Coupon rate

1,000.00
2.00 years
4%

Solution:

a.
b.
c.
d.

First-Year
Cash Flow

Second-Year
Cash Flow

$
$
$
$

$
$
$
$

40.80
41.60
42.40
43.20

1,082.02
1,124.86
1,168.54
1,213.06

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Challenge Problem 28
Suppose interest rates increase from 8% to 9%. Which bond will suffer the greater percentage
decline in price: a 30-year bond paying annual coupons of 8% or a 30-year zero-coupon bond?
Face value
Interest rate 1
Interest rate 2
Time
Coupon

$ 1,000.00
8.00%
9.00%
30.00 years
8.00%

Solution:
Coupon bond
Initial price
New price
Price decline %

=
=
=

$ 1,000.00
$ 897.26
10.27%

=
=
=

$
$

Zero-coupon bond
Initial price
New price
Price decline %

99.38
75.37
24.16%

Hence zero-coupon bond will suffer greater price decline.

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Challenge Problem 29
Consider two 30-year maturity bonds. Bond A has a coupon rate of 4%, while bond B has a coupon
rate of 12%. Both bonds pay their coupons semiannually
a. Construct an Excel spreadsheet showing the prices of each of these bonds for yields to maturity
ranging from 2% to 15% at intervals of 1%. Column A should show the yield to maturity
(ranging from 2% to 15%), and columns B and C should compute the prices of the two
bonds (using Excels bond price function) at each interest rate.
b. In columns D and E, compute the percentage difference between the bond price and its value
when yield to maturity is 8%.
c. Plot the values in columns D and E as a function of the interest rate. Which bonds price is
proportionally more sensitive to interest rate changes?
Face value
Coupon rate bond A
Coupon rate bond B
Time
Yield to maturity

100.00
4.00%
12.00%
30.00 years
8.00%

-144.96 kr
-119.69 kr
-100.00 kr

Solution:
c.
a., b.
Yield
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%

Price A
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?

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


#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?
#ADDIN?

1200%

1000%

800%

600%

400%

200%

0%

% Diff. (8%

12.00
10.00

The price of bond A is more sensitiv

8.00
Price
A

6.00
4.00
2.00
-

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8.00
Price
A

6.00
4.00
2.00
0%

2%

4%

6%

8%

10% 12% 14% 16%

here you can see the higher the yield to maturity (IRR), the lower the bond price.

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B has a coupon

ields to maturity

and its value

1200%

1000%

800%

600%

400%

200%

0%

% Diff. (8%) A

% Diff. (8%) B

The price of bond A is more sensitive to interest rate changes as reflected in the steeper curve.

2012, The McGraw-Hill Companies

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Challenge Problem 30
In Figure 6.7, we saw a plot of the yield curve on stripped Treasury bonds and pointed out that
bonds of different maturities may sell at different yields to maturity. In principle, when we are valuing
a stream of cash flows, each cash flow should be discounted by the yield appropriate to its particular
maturity. Suppose the yield curve on (zero-coupon) Treasury strips is as follows:
Time to Maturity
1 year
2
35
610

YTM
4.00%
5%
5.50%
6%

You wish to value a 10-year bond with a coupon rate of 10%, paid annually.
a. Set up an Excel spreadsheet to value each of the bonds annual cash flows using this table of
yields. Add up the present values of the bonds 10 cash flows to obtain the bond price.
b. What is the bonds yield to maturity?
Face value
Coupon rate
Time to maturity

recall: Yield to maturity is internal rate of return (IRR, overall inte


$

1,000.00
10.00%
10.00 years

Solution:
a., b.
Cash Flow
from Bond
100.00
100.00
100.00
100.00
100.00
100.00
100.00
100.00
100.00
1,100.00

PV of cash
flow
96.153846154
90.702947846
85.161366418
80.72167433
76.513435384
70.496054044
66.505711362
62.741237134
59.189846353
614.23425461

Bond price (PV)

1302.4203736

YTM (RATE)

5.91%

Year

YTM

1
2
3
4
5
6
7
8
9
10

4.00%
5.00%
5.50%
5.50%
5.50%
6.00%
6.00%
6.00%
6.00%
6.00%

2012, The McGraw-Hill Companies

its particular

stripped Treasury bonds:every coupon payment can be seen as a


zero coupon bond with time to maturity of the coupon payment.

l rate of return (IRR, overall interest rate) earned by an investor who buys the bond today at the market price.

2012, The McGraw-Hill Companies

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