CA Final SFM Solve Questions On Bond Valuation by Prof GDTPE140

Bond Analysis
& Valuation
Solutions
Category of Problems
1.
2.
3.
4.
5.
6.
7.
8.
9.
Bond Price...2
YTM Calculation 14
Duration & Convexity of Bond 30
Immunization 58
Forward Rates & Spot Rates Calculation... 66
Clean Price & Dirty Price 84
Bond Refunding Decision 88
Convertible Bond. 92
Mixed Problems 102
Prof Manish Ramuka
Topic Bond Markets
Page 1
Category #1: Bond Price

Problem #1
Consider three bonds with 8 percent 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.
What will happen to the price of each bond if their yields increase to 9 percent? What will
happen to the price of each bond if their yields decrease to 7 percent?
What do you conclude about the relationship between time to maturity and the sensitivity
of bond prices to interest rates?
Solution
Coupon rate = 8%
Bond Maturity
1
4 Yrs
2
8 Yrs
3
30 Yrs
If YTM increase to 9% Price of bond will decrease.
Bond 1
Price
Price
=
=
=
=
C X PVIFA (K%, n)
80 * PVIFA (4, 9%)
(80 x 3.240)
967.2//
+
+
+
FV X PVIF (K%, n)
1000 * PVIF (4, 9%)
(1000 x 0.708)
Similarly we can calculate other bond prices
Yield7%
Yield8%
Yield9%
Bond1
1033
1000
967
Prof Manish Ramuka
Bond2
1059
1000
944
Bond3
1124
1000
897
Topic Bond Markets
Page 2
Problem #2
A bond has a face value of Rs1,000 with maturity of 5 year and a coupon rate of 7% per
annum. If interest rates go down from 9% to 7% what will the capital gains from the bond
be?
Solution
Since interest rates are expected to go down from 9% to 7% price will increase as per
Meikles theorem
Find price of Bond when yield is 9%
Bond Price = C * PVIFA (k%, n) + Bn * PVIF (k%,n)
Price = 70 PVIFA 9%, 5 + 1000 PVIF 9%, 5
= 70 3.890 + 1000 0.650
= 922.3//
Find price of Bond when yield is 7%

Since YTM is same as coupon price =1000
Capital gain =
= . %//
1000 922.3
922.3
Prof Manish Ramuka
Topic Bond Markets
Page 3
Problem #3
Bonds A and B have Rs1000 face values, 8% YTM and 10 year terms to maturity. Bond a
pays coupon of 10% and Bond B trades at par, both making annual coupon payments. If the
yields decline to 6% what is the percentage price change in both bonds?
Solution
Step I: Find Price of 2 bonds today
Bond Price
Bond A
= C * PVIFA (k%, n) + Bn * PVIF (k%,n)

= 100 PVIFA 8%, 10 + 1000 PVIF 8%, 10
= 1134.20
Bond B
= 1000 Since Yield is same as coupon
Step II: Find price of 2 bonds when rates changes to 6%

Bond A
Bond B
= 1294
= 1147
Step III : % Change in Price

Bond A =
1294 1134.2
= . %
1134.2
Bond B = . %
Prof Manish Ramuka
Topic Bond Markets
Page 4
Problem #4
Shyam owns an Rs1000 face value bond with three years maturity. Bond makes an annual
coupon of 7.5%. The first coupon is due one year from now. Bond is selling today at
Rs975.48. If the YTM is 10%, should shyam sell the bond or hold it?
Solution
Step I Find intrinsic value (Price) of bond
IV
= 75 PVIFA 10%, 3 + 1000 8 PVIF 10%, 3

= 937.8
Step 2 Compare it with actual market value

Actual Market price is 975.48
Since Market Price > Intrinsic Value
Shyam should sell the bond
Problem #5
Consider a two-year Rs. 1000 face value 10% coupon rate bond which pays coupon semiannually. Find out the intrinsic value of the bond if the required rate of return is 14% p.a.
Compounded semi-annually. Should the bond be purchased at the current market price of
Rs. 965?
Solution
Bond Price
Bond Price
Bond Price
k
k
= Coupon PVIFA (( )%, 2n) + Bn PVIF (( )%, 2n)
2
2
= 50 * PVIFA (7%, 4) + 1000* PVIF (7%,4)
= 932.25
Since intrinsic Value (932.25)< Market Price (965) implies bond is trading at premium.
Hence bond should not be purchased at the current market price.
Prof Manish Ramuka
Topic Bond Markets
Page 5
Problem #6
Solution
Current yield
=
=
10
110
9.09%
If yield goes up by 1%
New Yield = 10.09%
Price
=
=
Bond Price
Prof Manish Ramuka
10
10.09%
99.1080 //
k
k
2
2
=
3.75*PVIFA (3%, 4) + 10000*PVIF (3%, 4)
375*3.7171 +
10278.78 //
10000*0.88848
Topic Bond Markets
Page 6
Problem #7
Solution
YTM = 16%
Redemption Price = 5% premium
Price of a bond = PV of future cash flows
9
1.16
10
(1.16)8
+
+
2 +
(1.16)
14
(1.16)9
Year
1
2
3
4
5
6
7
8
9
10
10
Prof Manish Ramuka
3 +
(1.16)
14
(1.16)10
Cash Flow
9
9
9
9
10
10
10
10
14
14
105
4 +
(1.16)
105
10
(1.16)
5 +
10
(1.16)6
10
(1.16)7
(1.16)10
PV Factor @ 16%
0.8621
0.7432
0.6407
0.5523
0.4761
0.4104
0.3538
0.3050
0.2630
0.2267
0.2267
Total
Topic Bond Markets
Present Value
7.76
6.69
5.77
4.97
4.76
4.10
3.54
3.05
3.68
3.17
23.80
71.29
Page 7
Problem #8
An Investor is considering the purchase of the following Bond. Find the Price.
Face Value
1000
Coupon Rate
8%
Maturity
3 years
Expected Return
15%
Solution
Bond Price = 80 * PVIFA (15%, 3) + 1000* PVIF (15%,3)
Bond Price = 80 * 2.283 + 1000 * 0.658
Bond Price = 840.64//
Problem #9
A bond with 7.5% coupon interest payable half yearly, Face Value 10,000 & Term to
maturity of 2 years in traded in the market. Find the Market Price of the Bond if the YTM is
10%. (Nov 2010)
Solution
k
k
Bond Price = Coupon PVIFA (( )%, 2n) + Bn PVIF (( )%, 2n)
2
2
Bond Price = 375 PVIFA ((
10
10
)%, 4) + 10000 PVIF (( )%, 4)
2
2
Bond Price = 375 3.546 + 10000 0.823
Bond Price = 9559.75
Prof Manish Ramuka
Topic Bond Markets
Page 8
Problem #10
Calculate the price and analyze the results:
Name
Coupon
Term-Years
Bond A
10%
5
Bond B
10%
5
Bond C
10%
5
Bond D
10%
10
Bond E
10%
10
Bond F
5%
5
Bond G
5%
5
Bond H
10%
15
Bond I
10%
15
YTM
10%
12%
8%
10%
12%
10%
12%
10%
12%
Price
YTM
10%
12%
8%
10%
12%
10%
12%
10%
12%
Price
1000
927.5
1080.3
1000
887
810.55
747.25
1000
864.1
Solution
Bond Price is calculated using following formula
Name
Bond A
Bond B
Bond C
Bond D
Bond E
Bond F
Bond G
Bond H
Bond I
Coupon
10%
10%
10%
10%
10%
5%
5%
10%
10%
Term-Years
5
5
5
10
10
5
5
15
15
State the results for YTM, Coupon Rate and Maturity
Prof Manish Ramuka
Topic Bond Markets
Page 9
Problem #11
A Rs. 1,000 face value ABC bond has a coupon rate of 6%, with interest paid semi-annually,
and matures in 5 years. If the bond is priced to yield 8%, what is the bonds value today?
Answer Price = Rs. 918.89
Solution
Bond Price
k
k
2
2
Bond Price
Bond Price
= 30 * PVIFA (4%, 10) + 1000* PVIF (4%,10)

= 918.89
Problem #12
The KLM bond has a 8% coupon rate, with interest paid semi-annually, a maturity value of
Rs. 1,000 and matures in 5 years. If the bond is priced to yield 6%, what is the bonds
current price?
Answer Price = Rs. 1085.2
Solution
Bond Price
k
k
2
2
Bond Price
Bond Price
= 40 * PVIFA (3%, 10) + 1000* PVIF (3%,10)

= 1085.2
Problem #13
Consider the following information related to a bond:
Par Value
Rs. 1000
Time to Maturity
15 Years
Coupon rate (interest payable annually)
8%
Current Market Price
Rs. 847.88
Yield to Maturity (YTM)
10%
Other things remaining the same, if the bond starts paying interest semi-annually, find the
change in the market price of the bond.
Answer New Price of Bond = Rs. 846.27
Solution
Bond Price
k
k
2
2
Bond Price
Bond Price
= 40 * PVIFA (5%, 30) + 1000* PVIF (5%,30)

= 846.27
Prof Manish Ramuka
Topic Bond Markets
Page 10
Problem #14
ABC Ltd. Has the following outstanding Bonds.
Bond
Coupon
Series X
8%
Series Y
Variable changes annually
Comparable to 10 years
prevailing rate
Maturity
10 Years
10 Years
Initially these bonds were issued at face value of Rs. 10,000 with yield to maturity of 8%.
Assuming that:
i. After 2 years from the date of issue, interest on comparable bonds is 10%, then what
should be the price of each bond?
ii. If after two additional years, the interest rate on comparable bond is 7%, then what
should be the price of each bond?
iii. What conclusions you can draw from the prices of Bonds, computed above.
Solution
Price of a floating rate bond remains same on every coupon reset date.
a)Price after 2 Yrs
Bond Price = 80 PVIFA 10%, 8 + 1000 PVIF 10%, 8
= 893.3
b)Price after 4 Yrs
Bond Price = 80 PVIFA 7%, 6 + 1000 PVIF 7%, 6
= 1047.6
Prof Manish Ramuka
Topic Bond Markets
Page 11
Problem #15
A 7% Bond issued several years ago when the market interest rate was also 7%. Now the
bond has a remaining life of 3 years when it would be redeemed at par value of Rs. 1,000.
The market rate of interest has increased to 8%. Find out the current market price, price
after 1 year and price after 2 years from today.
Solution
a) Bond Price Today (Remaining Life 3 Yrs)
Bond Price = 974.22
b) Bond Price after 1 yr (Remaining Life 2 Yrs)
Bond Price = 982.16
c) Bond Price after 2 yrs (Remaining Life 1 Yr)
Bond Price = 990.7
Problem #16
A Deep Discount Bond (DDB) was issued by a financial institution for a maturity period of
10 years and having a par value of Rs. 25,000. Find out the value of the Bond given that the
required rate of return is 16%.
Solution
Since the bond is a zero coupon bond coupon rate will be zero.
Bond Price = 25000* PVIF (16%,10)
Bond Price = 5667.1
Prof Manish Ramuka
Topic Bond Markets
Page 12
Problem #17
(a) A Rs. 100 perpetual bond is currently selling for Rs. 95. The coupon rate of interest is
14.5 percent and the appropriate discount rate is 16 percent. Calculate the value of the
bond. Should it be bought? What is its yield at maturity?
(b) A Company proposes to sell ten-year debentures of Rs. 10,000 each. The company
would repay Rs. 1,000 at the end of every year and will pay interest annually at 15 percent
on the outstanding amount. Determine the present value of the debenture issue if the
capitalization rate is 18 percent.
Solution
a)
Intrinsic Value of Perpetual Bond =
Coupon
YTM
Intrinsic Value of Perpetual Bond =
14.5
= 90.625
0.16
Since market value>intrinsic value we can conclude that the bond is currently overpriced.
Hence the bond should not be purchased.
YTM =
14.5
= 15.26%
95
b)
Year
1
2
3
4
5
6
7
8
9
10
Beginning
Principal
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
Prof Manish Ramuka
Principle
Payment
1000
1000
1000
1000
1000
1000
1000
1000
1000
1000
Interest Ending
Principle
1500
9000
1350
8000
1200
7000
1050
6000
900
5000
750
4000
600
3000
450
2000
300
1000
150
0
Topic Bond Markets
Total
CF
2500
2350
2200
2050
1900
1750
1600
1450
1300
1150
PV Factor
@ 18%
0.8475
0.7182
0.6086
0.5158
0.4371
0.3704
0.3139
0.2660
0.2255
0.1911
Total
Present
Value
2119
1688
1339
1057
831
648
502
386
293
220
9082
Page 13
Category #2: YTM

Problem #18
ABC Ltd. Recently issued 15-year bonds. The bonds have a coupon rate of 7.5 percent and
pays interest semiannually. The bonds are callable in 5 years at a call price equal to 13
percent premium to par value. The par value of the bonds is Rs1,000. If the yield to
maturity is 6 percent, what is the price of the bond today and what is yield to call?
Solution
Coupon Rate = 7.5%
Maturity = 15 Yrs
Semiannual coupon payment
Bond is callable in 5 Yrs
YTM = 6%
Price
Price
=
=
=
=
C X PVIFA (K%, n)
+
FV X PVIF (K%, n)
37.5 * PVIFA (30, 3%)
+
1000 * PVIF (3%, 30)
37.5 x 19.6 +
1000 x 0.412
1147.02
YTC is calculated as follows

1147.02
= 37.5 * PVIFA (10, x %)
1130 * PVIF (x%, 10)
+
+
PVIF 1130 (3%, 10)

1130 * 0.744
First lets find if equation matches at YTM of 6%

Price
= 37.5 * PVIFA (3%, 10)

= 37.5 * 8.530
= 1160.59
Here since the price is greater we will solve it using higher rate YTM of 7% to get lower
price
Calculating price @ YTM of 7%
Price
= 37.5 * PVIFA (3.5%, 10)
= 37.5 * 8.3160
= 1112.9
+
+
PVIF 1130 (3.5%, 10)

1130 * 0.7089
Now we can use interpolation to get exact answer

PV@Lower% Actual PV desired
YTM = Lower % +
(Difference in Yield)
(PV@Lower% PV@Higher%)
YTC
6%
6.28%
Prof Manish Ramuka
1160 .591147 .02

1160 .591112 .9
Topic Bond Markets
(7% - 6%)
Page 14
Problem #19
It is now January 1,2010, and Mr. X is considering the purchase of an outstanding Municipal
Corporation bond that was issued on January 1,2007, the Municipal bond has a 9.5%
annual coupon and a 30-year original maturity (it matures on December 31, 2037). Interest
rates have declined since the bond was issued, and the bond now is selling at 116.575% of
par, or Rs. 1,165.75. Determine the yield to maturity (YTM) of this bond for Mr. X.
Solution
Coupon Rate = 9.5%
Maturity = 27Yrs
Price
= C X PVIFA (K%, n)
FV X PVIF (K%, n)
1000*PVIF (8%, 27)
First lets find if equation matches at YTM of 8%

Price
= 95 * PVIFA (8%, 27)

= 1164
Here since the price is less we will solve it using lower rate YTM of 7.5% to get higher price
Calculating price @ YTM of 7.5%
Price
= 95 * PVIFA (7.5%, 27)
= 1228.8
1000* PVIF (7.5%, 27)

YTM = Lower % +
YTC
7.5%
7.98%
Prof Manish Ramuka
1228 .8.591165.75
1228 .81164
Topic Bond Markets
(8% - 7.5%)
Page 15
Problem #20
There is a 9%, 5 year bond issue in the market. The issue price is Rs90 and the redemption
price is Rs105. For an investor with marginal income tax rate of 30% and capital gains tax
of 10% (assuming no indexation), what is the post tax yield to maturity?
Solution
Price of bond can be calculated as follows
Price = C X PVIFA (K%, n)
FV X PVIF (K%, n)
90
= [9 X (1-30%)] * PVIFA (K%, 5) + [105 10% (15)] * PVIF (K%, 5)
90
= 6.3 PVIFA (K%, 5)
103.5 PVIF (K%, 5)
@ YTM of 10%
Price = 88.1472
@ YTM of 9%
Price = 91.7727
Using Interpolation
YTM = Lower % +
YTM

= 9% +
91.77 90
91.77 88.14
9% - 8%
= 9.4876%
Prof Manish Ramuka
Topic Bond Markets
Page 16
Problem #21
Solution
Maturity
Price
Coupon
=
=
=
6 Yrs
95
13%
We will use interpolation

Calculate price of bond @ YTM of 14%
Price
=
13*PVIFA (14%,6) + 100*PVIF (14%, 6)
=
96.11
Price
=
92.43%
Using interpolation
PV @ Lower Actual Desired
(High % Low %)
PV @ Lower PV @ Higher
YTM
= Low % +
YTM
14% +
14.30%//
Prof Manish Ramuka
96.1195
96.1192.43
* 1%
Topic Bond Markets
Page 17
Problem #22
Solution
Bond Price
C * PVIFA (k%, n) + Bn * PVIF (k%,n)
Bond Price
=
=
11*PVIFA (13%, 3) + 100*PVIF (13%, 3)

95.27

Since coupon rate =
YTM
Bond Price
=
100
Bond Price
=
95.27 from above
Using interpolation
YTM
= Low % +
YTM
= 11% +

(High % Low %)
100 97.6
(13% 11%)
100 95.27
= 12%
Prof Manish Ramuka
Topic Bond Markets
Page 18
Problem #23
Solution
a) 364 Day T-bill rate = 9%
Hence rate for AA rated bond = 9% + 3% + 2% = 14%
Price
= 150 * PVIFA (14%, 5) + 1000 * PVIF (14%, 5)

= 150 * 3.433
+ 1000 * 0.519
= 1034.3//
Since intrinsic value of 1034.3 > is greater than market price of 1025.86 he should
consider investing in bonds.
b) Current yield
150
1025 .86
14.62%//
c) YTM calculation
Calculation Price @ 14%
Price @ 15%
=
=
1034.3
1000
Using interpolation
YTM
= Low % +
YTM
= 14% +
=
Prof Manish Ramuka

(High % Low %)
[ 1034 .31025 .86]

[1034 .31000 ]
* (5-14%)
14.23%. //
Topic Bond Markets
Page 19
Problem #24
Arvind Ltd recently issued 15 year bonds. The bonds have a coupon rate of 7.5 percent and
pays interest semi-annually. The bonds are callable in 5 years at a call price equal to 13%
premium to par value. If the par value of the bonds is Rs1,000, if the yield to maturity is 6
percent, what is yield to call ?
Solution
Step 1: To calculate current price of bond
Bond Price
k
k
Coupon PVIFA (( )%, 2n) + Bn PVIF (( )%, 2n)
2
2
=
=
=
37.5 * PVIFA (3%, 30) + 1000 * PVIF (3%, 30)

37.5 * 19.6 + 1000 * 0.412
1147
Step 2: Calculate YTC

Calculating bond price @ YTM of 8%
k
k
Bond Price =
Coupon PVIFA ((2)%, 2n) + Bn PVIF ((2)%, 2n)
=
=
=
37.5 * PVIFA (4%, 10) + 1130 * PVIF (4%, 10)

37.5 * 8.111 + 1000 * 0.676
1067.96
Similarly calculating bond price @ YTM of 4%

Bond Price =
1263.46
YTC = Low % +
YTM = 4% +

(High % Low %)
1263.46 1147
(8% 4%)
1263.46 1067.96
YTM = 6.38%//
Prof Manish Ramuka
Topic Bond Markets
Page 20
Problem #25
A bond is issued at 10% discount to its face value of Rs1lakh. Redemption takes place at the
end of 20 years. If the coupon is 12% and bonds are redeemed at Rs110000, what is the
YTM as per approximate method?
Solution
Yield to maturity can be calculated using approximate formula as follows
YTM =
(F P)
n
(F + P)
n
C+
110000 90000
20
110000 + 90000
2
12000 +
= . %//
Prof Manish Ramuka
Topic Bond Markets
Page 21
Problem #26
Arvind recently purchased a bond with Rs1000 face value, coupon 10% and four years to
maturity. The bond makes annual interest payments and the first one is due one year from
now. Arvind paid Rs1032.40 for the bond.
What is bonds YTM?
If the bond can be called in two years at Rs1100, what is its yield to call?
Solution
FP
C+ n
YTM Approximate =
F+P
2
YTM
10 +
100 103.24
4
203.24
2
= . %
For yield to call we do it using the interpolation logic
Bond Price @ 14% = 100 PVIFA 14%, 2 + 1100 PVIF 14%, 2
= 1011
Bond Price @ 12% = 100 PVIFA 12%, 2 + 1100 PVIF 12%, 2
= 1045.9
Using interpolation we calculate YTC
YTM = Low % +
YTC = 12% +

(High % Low %)
13.5
2%
13.5 + 21.4
= . % //
Prof Manish Ramuka
Topic Bond Markets
Page 22
Problem #27
Shyam recently purchased at par bond with Rs1000 face value, coupon 9% and four years
to maturity. Assuming annual interest payment, calculate shyams actual YTM if all interest
payments are reinvested at 15% per annum. What is Shyams actual YTM if all interest
payments are immediately spent on receipt ?
Solution
Bonds Present Value = 1000
Coupon payments = 90
Reinvestment Income = (90 1.153 ) + (90 1.152 ) + (90 1.151 ) + 90 360
= 449.4 360
= 89.4
YTM is calculated as follows

1000 = PVIF X, 4 1000 + 449.4
YTM = 9.72%
When all dividends are spent that means no reinvestment income is received.
1000 = PVIF X, 4 1000 + 360
= %//
Prof Manish Ramuka
Topic Bond Markets
Page 23
Problem #28
Mr. Praveen is working as a Senior Manager in a Public Sector Undertaking. His gross total
income is Rs. 5, 00,000 p.a. He would like to avail the benefit of tax rebate (@15%) under
section 88 of the Income Tax Act, by investing Rs. 2, 00,000 in the Tax Saving Bonds issued
by the ICICI Bank. Options available of Mr. Praveen in respect of Tax Saving Bonds are given
below:
Option
Issue Price
Face Value
Tenure
Interest (%)
Interest
Rs.
Rs.
(p.a.)
Payable
I
10,000
10,000
4 Years
5.65
Annually
II
10,000
10,000
6 Years
7.00
Annually
III
10,000
14,750
4 Years 9
DDB*
DDB*
months
IV
10,000
17,800
6 Years 9
DDB*
DDB*
months
Deep Discount Bond
The marginal tax rate applicable to Mr. Praveen is 30%
You are required to:
(a)
Determine the post-tax YTM for the four options available to Mr. Praveen
Assume that the interest income is tax exempt.
(b)
Suggested an option, if
i)
The yield curve is upward sloping
ii)
The yield curve is downward slopping
iii)
The yield curve is flat
Answer Price YTM = 10.16%, 10.27%, 12.3%, 11.57%
Solution
a) Calculating Post Tax YTM for 4 bonds
Bond 1
Coupon Received (C)
Current Price (P)
Redemption Amount (F)
No of Years (n)
= 5.65% * 10,000 = 565

= 10,000 (15% * 10,000) = 8,500
= 10,000
= 4yrs
FP
C+ n
YTM Approximate =
F+P
2
YTM Approximate =
Post Tax YTM = 10.16%

Prof Manish Ramuka
10,000 8,500
4
10,000 + 8,500
2
565 +
Topic Bond Markets
Page 24
Bond 2
Coupon Received (C)
Current Price (P)
Redemption Amount (F)
No of Years (n)
= 7% * 10,000 = 700
= 10,000 (15% * 10,000) = 8,500
= 10,000
= 6yrs
FP
C+ n
YTM Approximate =
F+P
2
YTM Approximate =
10,000 8,500
6
10,000 + 8,500
2
700 +
Post Tax YTM = 10.27%

Bond 3
FV = PV (1 + Periodic Rate)ny
9
14,750 = 8,500 (1 + YTM)(4+12 )

YTM = 12.31%
Bond 4
FV = PV (1 + Periodic Rate)ny
9
17,800 = 8,500 (1 + YTM)(6+12 )

YTM = 11.57%
b)
Yield Curve is upward sloping
This implies that interest rates are expected to rise. This will imply that bond prices should
fall. Hence we should buy the bonds with lowest maturity i.e Bond 1
Yield Curve is Downward sloping
This implies that interest rates are expected to fall. This will imply that bond prices should
rise. Hence we should buy the bonds with highest maturity i.e Bond 4
Yield Curve is flat
This implies that interest rates are not expected to change. Hence the choice of bond should
not depend on maturity. We should simply buy the bond with highest YTM i.e Bond 3
Prof Manish Ramuka
Topic Bond Markets
Page 25
Problem #29
A Rs. 1,000 face value EFG bond has a coupon of 10% (paid semi-annually) matures in 4
years, and has current price of Rs. 1140 what is the EFG bonds yield to maturity?
Answer BEY = 6.08% Compounded Semi annually
Solution
k
k
Bond Price =
=
=
50 * PVIFA (4%, 8) + 1000* PVIF (4%, 8)

1067.32

Bond Price =
1140.39
YTM = 6%
Problem #30
A NOP bond has an 8% coupon rate (semi-annual interest), a maturity value of Rs. 1,000,
matures in 5 years, and a current price of Rs. 1,200. What is the NOPs yield-to-maturity?
Answer 3.6155%
Solution
k
k
Bond Price =
=
=
40 * PVIFA (2.5%, 10) + 1000* PVIF (2.5%, 10)

1131.28

Bond Price =
1230.55
Using interpolation
YTM
= Low % +
YTM
= 3% +

(High % Low %)
1230.55 1200
(5% 3%)
1230.55 1131.28
= 3.6155%
Prof Manish Ramuka
Topic Bond Markets
Page 26
Problem #31
Consider a Rs. 1000 face value, 5 years bond presently trading at Rs. 972. The bond has
coupon rates of 14% payable semiannually. Compute its current yield?
Answer Current Yield = 7.20%
Solution
Current Yield =
Annual Coupon
140
=
= 14.4%
Current Price
972
Prof Manish Ramuka
Topic Bond Markets
Page 27
Problem #32
(a) Consider a 1 year Rs. 1000 face value, 12% coupon bond which pays coupon annually.
The bond was issued 5 Years and was trading at Rs. 960. The bond is redeemable at a
premium of 10% on maturity. If income tax rate is 30% and capital gains tax is 10%, find
out post tax YTM. If the post tax required rate of return is 12.5%, give your investment
advice.
(b) Suppose in the previous sum there are no taxation issues. Moreover the bond is to be
redeemed at a premium of 10% in 2 equal annual installments at the end of 9th year and
10th year, find out the YTM of the bond.
Answer YTM (a) 10.67%, (b) 15%
Solution
a)
Coupon Payment After tax = Coupon * (10Tax Rate)
= 12% * 1000 (1-30%)
= 84
Face Value After Tax
= Face Value Capital Gain Tax

=1100 10%(1100-960)
=1086
FP
C+ n
YTM Approximate =
F+P
2
YTM
1086 960
5
1086 + 960
2
84 +
= . %
b)
Year
1
2
3
4
5
Coupon Cash Flow

120
120
120
120
60
Principal
550
550
Total Cash Flow

120
120
120
670
610
YTM is calculated as follows

Outflow = PV of Future Cash Inflows
Solve Using interpolation such that it satisfies the following equation
960 =
120*PVIFA(YTM,3) + 670*PVIF(YTM,4)+ 610*PVIF(YTM,5)
YTM=15%
Prof Manish Ramuka
Topic Bond Markets
Page 28
Problem #33
IDBI, in its issue of Flexi bonds 3, offered Growing Interest Bond. The interest will be paid
to the investors every year at the rates given below and the minimum deposits is Rs.
5000/-,
Year
1
2
3
4
5
Interest
10.5%
11.0%
12.5%
15.25%
18.0%
(p.a.)
Calculate the yield to maturity (YTM)
Answer YTM = 13%
Solution
YTM should be calculated in such a way that it satisfies the following equation
Outflow = PV of Future Cash Inflows
5000 =
10.5% 5000 11% 5000 12.5% 5000 15.25% 5000 18% 5000
+
+
+
+
1 + YTM 1
1 + YTM 2
1 + YTM 3
1 + YTM 4
1 + YTM 5
By trial and error and using interpolation we get

YTM=13%
Prof Manish Ramuka
Topic Bond Markets
Page 29
Category #3: Duration & Convexity of Bond

Problem #34
Calculate duration of a six year bond whose face value is Rs1000 and which pays a coupon
of 8%. Assume the yield to be 8%.
Solution
Duration of bond =?
Year(1)
1
2
3
4
5
6
Duration
CF(2)
80
80
80
80
80
1080
4=1 x 2 x 3
74.07
137.168
190.51
235.2
272.25
4083.6
4992.88
Total of Column 4
Price
4992.88
1000
4.99288
5 Yrs //
Prof Manish Ramuka
PV Factor(3)
0.9259
0.8573
0.7938
0.7350
0.6806
0.6302
Total
Topic Bond Markets
Page 30
Problem #35
Calculate duration of a semi annual coupon bond with an 8% coupon on 1000 face value
bond with 2 years to maturity and an YTM of 10%
Solution
YTM
= 10%
1
Year
0.5
1
1.5
2
Duration =
Duration
2
CF
40
40
40
1040
3
PV Factor
0.9524
0.9070
0.8638
0.8227
4 - 3x2
PV
38.0960
36.2800
34.5520
855.6080
= 964.57
5
4x1
19.0480
36.28
51.828
1771.22
= 1818.37
1818.37
964.57
= 1.8852//
Prof Manish Ramuka
Topic Bond Markets
Page 31
Problem #36
An inflow of Rs25lakhs is to be invested in the following bond portfolio in the percentages
specified.
Bond
1
2
3
4
5
% of money invested
10
27
7
50
6
Macaulay Duration of bond

10.6
6.9
12.5
2.0
8.3
The face value of all bonds is Rs1000 and the YTM is 9%. Calculate the duration of the
portfolio. What would be the percentage change in price of bond 1 if the interest rates fall
to 7%? Also ascertain the percentage change in Portfolio value
Solution
Macaulay duration of bond portfolio
=
=
10% x 10.6 + 27% x 6.9 + 7% x 12.5 + 50% x 2+ 6% x 8.3

5.3
Modified duration of portfolio
=
=
% Change in bond 1 price
=
=
5.3
(1+9%)
4.8624
10.6
2
(1 + 9%)
19.45%
% change in price of portfolio
=
=
4.8624 x 2
9.7248%
Prof Manish Ramuka
Topic Bond Markets
Page 32
Problem #37
The following data are available for a bond:
a.
Face value
1,000
b.
Coupon Rate
16%
c.
Years to maturity
6
d.
Redemption value 1,000
e.
Yield to maturity
17%
What are the current market price, duration and volatility of this bond? Calculate the
expected market price, if we witness an increase in required yield by 75 basis points.
Solution
Price =
=
=
160 x PVIFA (17%, 6)

3.589 X 160
964.24//
Duration Calculation
1
Yrs
1
2
3
4
5
6
Duration
2
CF
160
160
160
160
160
1160
=
=
Modified Duration
+
+
1000 X PVIF (17%, 6)

1000 X 0.390
3
PV
0.8547
0.7305
0.6244
0.5337
0.4561
0.3898
4
1x2x3
136.75
233.76
299.71
341.56
364.8
2713.6
= 4089.78
4089.78
964.24
4.24 //
4.24
1+17%
3.6261 //
% Change is bond price

=
=
0.75 x
2.7196%
3.6261
Bond Price will decrease by 2.7196%

New Price
=
964 X [1 2.7196%]
=
937.78 //
Prof Manish Ramuka
Topic Bond Markets
Page 33
Problem #38
The modified duration for a 12 year 6% annual coupon bond yielding 7% is calculated to be
8.245.
a) If the yield falls to 6.8%, what is the percentage price change for this bond using the
modified duration value?
b) What is the actual percentage price change for this bond?
c) If the yield falls to 6.0%, what is the percentage price change for this bond using the
modified duration value?
d) What is the actual percentage price change for this bond?
Solution
a)
% change in price of bond
=
=
0.2% X 8.245
1.6490%//
b)
Actual % change in price
New Price
=
=
60 X PVIFA (6.8%, 12)

935.77
1000 X PVIF (6.8%, 12)
Original Price
=
=
60 X PVIFA (7%, 12)

920.57
1000 X PVIF (7%, 12)
% Change
=
=
935.77920.57
920.57
X 100
1.65%//
C) Similar calculation can be performed.

D) Similar calculation can be performed.
Prof Manish Ramuka
Topic Bond Markets
Page 34
Problem #39
Calculate Convexity given the following with respect to a coupon bond. Coupon rate = 6%,
Term = 5 years, Yield to maturity = 7% (3.5% semi-annual) and Price = 958.42.
Solution
1
Yrs
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Convexity
2
Yrs (Yrs + 1)
0.75
2.00
3.75
6.00
8.075
12.00
15.75
20.00
24.75
30.00
3
CF
30
30
30
30
30
30
30
30
30
1030
4
PVF
0.9662
0.9335
0.9019
0.8714
0.8420
0.8135
0.7860
0.7594
0.7337
0.7089
5
2x3x4
21.73
56.00
101.46
156.85
221.00
292.86
371.38
455.64
544.77
21905
= 24126
24126
958.42 (1 + 7%)2
Prof Manish Ramuka
21.98//
Topic Bond Markets
Page 35
Problem #40
Solution
a) Bond Price = C * PVIFA (k%, n) + Bn * PVIF (k%,n)
Price
= 160 * PVIFA (17%, 6) + 1000 * PVIF (17%, 6)

= 964.11 //
b) Duration
Yrs
1
2
3
4
5
6
CF
160
160
160
160
160
1160
c) Volatility =
PV Factor
0.8547
0.7305
0.6244
0.5337
0.4561
0.3898
1x2x3
136.75
233.76
299.71
341.56
364.88
2713.1
4089.5
4089.58
964.1082
=4.247 Years//
Macaulay Duration
(1+K)
4.247
1.17
= 3.63%//
d) Expected Market Price % change

= -3.63% * 0.75
= - 2.7224%
New Price
Prof Manish Ramuka
= 964.24 (1 2.7224%)
= 937.98//
Topic Bond Markets
Page 36
Problem #41
Arvind wants to invest in a bond that matures after 6 years from now. The face value of the
bond is Rs1000 and carries a coupon rate of 10.75%. If the bond is currently trading at
Rs950,
Calculate
Modified duration of bond
Price change if interest rate increases by 0.5%
Solution
In order to find modified duration we need YTM and Macaulay duration
Step1: Calculate YTM using interpolation
Since price is lower than face value we select YTM to be higher than coupon rate.
Price = 948.6074
Since above price is less than actual price we select next rate to be lower than 12%
Calculating bond price @ YTM of 11.5%
Price = 968.7228
YTM = Low % +
YTM = 12% +

(High % Low %)
968.73 950
(12% 11.5%)
968.73 948.61
YTM = 11.97%
Prof Manish Ramuka
Topic Bond Markets
Page 37
Step2: Calculate Macaulay duration

nt=1
Macaulay Duration =
tc
n Bn
+
(1 + k)t (1 + k)t
B0
1
Yrs
2
CF
1
2
3
4
5
6
107.5
107.5
107.5
107.5
107.5
1107.5
Macaulay Duration =
3
PV Factor @
11.97%
0.8931
0.7976
0.7123
0.6361
0.5682
0.5074
4
PV (3x2)
5
4x1
96.00
85.70
76.56
68.39
61.08
561.9
950
96
171.4
229.68
273.56
305.4
3371.4
4447.4
4447.4
950
= 4.6815//
Modified Duration =
Macaulay Duration
(1 + k)
4.6815
(1 + 11.97%)
= 4.1818//
% Change in Bond Price
Prof Manish Ramuka
=
=
=
- [Modified Duration] *[% Change in Yield]

-4.1818 * 0.5
-2.1%//
Topic Bond Markets
Page 38
Prof Manish Ramuka
Topic Bond Markets
Page 39
Problem #42
The duration for a bond paying semi-annual coupon is 6.72 years for a maturity of 10 years.
If the YTM of bond is 12.5% with a coupon rate of 11% and the face value is Rs100, what is
the modified duration of the bond?
Solution
Macualay Duration = 6.72
Modified Duration =
=
6.72
12.5%
(1 + 2 )
6.72
1 + 6.25%
6.72
1.0625
Macualay Duration
k
(1 + 2)
= 6.3247
Problem #43
Four bonds are held by Ram (Durations and Proportion given below)
Bond
Duration
Proportion
A
4.50 years
0.20
B
3.00 years
0.25
C
3.50 years
0.25
D
2.80 years
0.30
What is the duration of Rams Bond Portfolio?
Solution
Portfolio Duration =
Wi Di
Portfolio Duration = 4.5 0.2 + 3 0.25 + 3.5 0.25 + 2.8 0.3

Portfolio Duration = 3.37
Prof Manish Ramuka
Topic Bond Markets
Page 40
Problem #44
Without calculating rank the following in the descending order of duration.
Bond
Maturity
Coupon %
A
30 years
10
B
30 years
0
C
30 years
10
D
5 years
10
YTM
10
10
7
10
Solution
Face value of a bond forms significant portion of cash flows from bond. Therefore longer
maturity bonds will return the cash flows later than a shorter maturity bond. Hence bonds
A, B, C will have higher duration than bond D. Bond D would be ranked last.
Zero coupon bonds do not give intermediate cash flows and the only cash flow from zero
coupon bond is its face value. This implies duration of a zero coupon bond is always higher
than the duration of coupon paying bond. Since bond B is a zero coupon bond with same
years to maturity as that of A & C, bond B will have higher duration as compared to A & C
and hence would be ranked first.
With all parameters same in 2 bonds, bond with higher yield to maturity will have lower
duration than a corresponding bond with a lower yield to maturity. This is because when
YTM is more, the reinvestment income is more and hence the cash flows from the bond is
received earlier since the coupons are reinvested at higher rates from the beginning. Hence
bond C with YTM equal to 7% is ranked second as compared to bond A which is ranked
third.
B, C, A, D
Prof Manish Ramuka
Topic Bond Markets
Page 41
Problem #45
Rank the following bonds in the descending order of duration:
(Calculate not allowed)
Bond
Coupon Rate
YTM
A
10%
14%
B
12%
14%
C
0%
14%
D
12%
16%
Maturity
10 years
10 years
10 years
10 years
Solution
Since all the bonds have same maturity we will draw our conclusions from the relationship
between coupon rate and YTM
Bond C is a zero coupon bond and hence will have maximum duration.
Bond B & D have same coupon rate however have different YTM. Bond having higher YTM
will have lower duration. Hence Bond B has higher duration in comparison to bond D.
B>D
Bond A & B have same YTM, however they have different coupon rate. Bond having higher
coupon rate has lower duration. Hence Bond B has lower duration in comparison to A
Hence we have following relationship for duration of the bonds mentioned above.
C>A>B>D
Prof Manish Ramuka
Topic Bond Markets
Page 42
Problem #46
Find the duration of a five year bond with Coupon = 10% and YTM = 10%, With FV = 1000
and coupons payable annually.
Solution
Duration of a bond is calculated using following formula
nt=1
Macaulay Duration =
tc
n Bn
+
(1 + k)t (1 + k)t
B0
1
Yrs
2
CF
1
2
3
4
5
100
100
100
100
1100
3
PV Factor @
10.0%
0.909
0.826
0.751
0.683
0.621
4
PV (3x2)
5
4x1
90.9
82.6
75.1
68.3
683.1
1000
90.9
165.2
225.3
273.2
3475.5
4170.1
Duration = 4.17yrs
Prof Manish Ramuka
Topic Bond Markets
Page 43
Problem #47
Find the duration of a five year bond with Coupon = 10% and YTM = 10% With FV = 1000
and coupons payable semi-annually. Is the answer different from the duration of the same
bond with annual coupons? Why?
Solution
Duration of a semiannual bond is calculated using following formula
2n
t=1
Macaulay Duration =
tc
n Bn
+
(1 + k)t (1 + k)t
B0
1
Yrs
2
CF
1
2
3
4
5
6
7
8
9
10
50
50
50
50
50
50
50
50
50
1050
Macaulay Duration =
=
Prof Manish Ramuka
3
PV Factor @
10.0%
0.952
0.907
0.864
0.823
0.784
0.746
0.711
0.677
0.645
0.614
4
PV (3x2)
47.61905
45.35147
43.19188
41.13512
39.17631
37.31077
35.53407
33.84197
32.23045
644.6089
1000
5
4x1
47.61
90.70
129.57
164.54
195.88
223.86
248.73
270.73
290.07
6446.08
8107
8107
1000 2
4.05
Topic Bond Markets
Page 44
Problem #48
Consider a bond selling at its par value of Rs1000 with 6yrs to maturity and 7% annual
coupon rate. What is bonds duration? If the YTM of this bond increases to 10%, how it
affects the bonds duration? And Why? Why should the duration of a coupon carrying bond
always be less than the time to its maturity?
Solution
Duration of a bond is calculated using following formula
nt=1
Macaulay Duration =
tc
n Bn
+
(1 + k)t (1 + k)t
B0
1
Yrs
2
CF
3
PV Factor @ 7%
4
PV (3*2)
5
4*1
1
2
3
4
5
6
Grand Total
70
70
70
70
70
1070
0.935
0.873
0.816
0.763
0.713
0.666
65.42
61.14
57.14
53.40
49.91
712.99
1000
65.42
122.28
171.42
213.61
249.55
4277.92
5100.20
Macaulay Duration =
5100
1000
5.1//
If k increases from 7% to 10%, coupons of Rs 70 would be reinvested at higher rates. This

will give us higher reinvestment income ahead of schedule
Prof Manish Ramuka
Topic Bond Markets
Page 45
Problem #49
Solution
FV
YTM
Macaulay duration
=
=
=
2n
t=1
Macaulay Duration =
100000
16%
4.3202
tc
n Bn
+
t
(1 + k) (1 + k)t
B0
And price of a bond is given as

Bond Price
Price
=
=
C*PVIFA (16%, 6) + 100000 PVIF (16%, 6)

3.685 C
+
0.4104*100000
Substituting in above eqn

1
2
3
4
5
6
100000 6
1.6 + 1.162 + 1.163 + 1.164 + 1.165 + 1.166 + 1.166
4.3202 =
3.685 + 41040
15.19C + 177392
4.5402C
C
=
=
=
11.36987C
68872
15169.37
246265
Substituting in equation for price we get

Price = 96943.14
Prof Manish Ramuka
Topic Bond Markets
Page 46
Problem #50
Find the current market price of a bond having face value of Rs1L redeemable after 6yrs
maturity with YTM at 8% payable annually and duration =4.9927yrs
Solution
FV
YTM
Macaulay duration
=
=
=
nt=1
Macaulay Duration =
100000
8%
4.992
tc
n Bn
+
(1 + k)t (1 + k)t
B0
And price of a bond is given as

Bond Price
Price
=
=
C*PVIFA (8%, 6) + 100000 PVIF (8%, 6)

4.623 C
+
0.63*100000
Substituting price in equation for bond

1
2
3
4
5
6
100000 6
1.08 + 1.082 + 1.083 + 1.084 + 1.085 + 1.086 + 1.086
4.992 =
4.623 + 63000
Solving we get
C
=
8000
Substituting in equation for price we get
Price = 1,00,000
Prof Manish Ramuka
Topic Bond Markets
Page 47
Problem #51
The modified duration for a 5 year 10% annual coupon bond yielding 10% is calculated to
be 3.79. Now if the yield falls to 8% what is the percentage price change for this bond using
the modified duration value? Is the answer same as that obtained using bond pricing
formula?
Solution
N=5yrs
C=10%
YTM = 10%
Modified Duration = 3.79
Change in yield = -2%
% Change in Bond Price = - [Modified Duration] *[% Change in Yield]
= - 3.79*-2%
= 7.58%
Actual percentage price change is calculate by calculating price of a bond at new YTM of 8%
Price = 1080.3
% Change in Bond Price = (1080.3 1000)/1000
% Change in Bond Price = 8.03%
The answers are not same because duration is first derivative of the bond pricing formula
and assumes a linear relationship between price and yield. Actually the relationship is not
linear but convex which is explained by the concept of convexity which is second derivative
of bond pricing formulae and gives more accurate answer.
Prof Manish Ramuka
Topic Bond Markets
Page 48
Problem #52
Consider a 12% Rs. 1000 FV, 5 Year bond presently trading at Rs. 970.
1) Compute its YTM
2) State the limitations of YTM.
3 Compute Macaulays duration.
4 Prove that Macaulays duration is the immunizing period.
Answer YTM = 12.84%
Solution
a)
Bond Price =
Coupon PVIFA (YTM%, n) + Bn PVIF (YTM%, n)
=
120* PVIFA (14%, 5) + 1000* PVIF (14%, 5)
=
931.4
Similarly calculating bond price @ YTM of 12.5%
Bond Price =
982.19
Using interpolation
YTM
= Low % +

(High % Low %)
YTM
= 12.5% +
982.2 970
(14% 12.5%)
982.2 931.4
= 12.84%
b)
YTM assumes that the intermediate cash flows are reinvested at the rate of YTM. This is not
always true as interest rates keeps on changing in the market, which could distort the
reinvestment income and hence change the realized YTM.
Prof Manish Ramuka
Topic Bond Markets
Page 49
c)
nt=1
Macaulay Duration =
1
Year
1
2
3
4
5
2
Cashflow
120
120
120
120
1120
Macaulay Duration =
Prof Manish Ramuka
tc
n Bn
+
(1 + k)t (1 + k)t
B0
3
PV Factor @ 12.84%
0.8862
0.7854
0.6960
0.6168
0.5466
Total
4
Present Value
106
94
84
74
612
970
5
4*1
106
188
251
296
3061
3903
3903
= 4.023
970
Topic Bond Markets
Page 50
Problem #53
Consider a 3 year Rs. 100000 face value bond presently yielding 14%. Its duration is 2.6
years. Find its coupon rate and price.
Answer C = 16.93%, Price = Rs. 106802.38
Solution
a)
1
Year
1
2
3
2
Cashflow
C
C
C + 100000
3
PV Factor @ 14%
0.8772
0.7695
0.6750
Total
nt=1
Macaulay Duration =
2.6 =
4
Present Value
0.8772C
0.7695C
0.6750C + 67,500
2.3216C + 67,500
5
4*1
0.8772C
1.5390C
2.025C+2,02,491
4.44C + 2,02,491
tc
n Bn
+
(1 + k)t (1 + k)t
B0
4.44C + 202491
2.3216C + 67500
Solving above equation we get

C = 16,930
b)
Bond Price = 16,930* PVIFA (14%, 3) + 100,000 * PVIF (14%,3)
Bond Price = 106802.38
Prof Manish Ramuka
Topic Bond Markets
Page 51
Problem #54
RAMESH wants to invest in a bond that matures after six years from now. The face value of
the bond is Rs. 1,000 and it carries a coupon rate of 10.75%. If the bond is currently trading
at Rs. 950, You are required to calculate:
a) The duration of the bond
b) The price of the bond if interest rate increases by 0.50%.
Answer D = 4.68 Yrs, Revised Price = Rs. 930.15
Solution
Step 1 Calculate the YTM of the bond
FP
C+ n
YTM Approximate =
F+P
2
YTM Approximate =
1000 950
6
1000 + 950
2
107.5 +
YTM Approximate = . %
YTM Actual = 11.96%
Step 2 Calculate Macaulay Duration
nt=1
Macaulay Duration =
1
Year
1
2
3
4
5
6
2
Cash Flow
107.5
107.5
107.5
107.5
107.5
1107.5
Macaulay Duration =
Prof Manish Ramuka
tc
n Bn
+
(1 + k)t (1 + k)t
B0
3
PV Factor @ 11.96%
0.8932
0.7978
0.7125
0.6364
0.5684
0.5077
Total
4
Present Value (3 x 2)
96.02
85.76
76.60
68.42
61.11
562.30
950.20
5
4x1
96.02
171.52
229.80
273.66
305.54
3373.79
4450.32
4450
= 4.684
950
Topic Bond Markets
Page 52
Step 3 Calculate Modified Duration

Modified Duration =
Macaulay Duration
(1 + k)
4.684
(1 + 11.96%)
= 4.18//
Step 4 Change in bond [price
New bond price
Prof Manish Ramuka
=
=
=

-4.18 * 0.5
-2.09%//
= 950 2.09%
= 930.15
Topic Bond Markets
Page 53
Problem #55
The following is the information related to a bond issued by a firm:
Date of Issue
Years of Maturity
Face Value (Rs)
Coupon Rate (%)
01.04.2003
6
1000
9
The bond will be redeemed at its face value and coupon is paid annually. The bond is
currently trading at Rs. 976.95.
You are required to:
(a) Calculate the duration of the bond
(b) Calculate the percentage change in the price of the bond if the yield increases by
50 basis points.
Answer D = 4.87 yrs, Revised Price = Rs. 955.21
Solution
Step 1 Calculate the YTM of the bond
FP
C+ n
YTM Approximate =
F+P
2
YTM Approximate =
1000 976.95
6
1000 + 976.95
2
90 +
YTM Actual = 9.52%
Step 2 Calculate Macaulay Duration
nt=1
Macaulay Duration =
1
Year
1
2
3
4
5
6
2
Cash Flow
90
90
90
90
90
1090
Prof Manish Ramuka
tc
n Bn
+
t
(1 + k) (1 + k)t
B0
3
PV Factor @ 9.52%
0.9131
0.8337
0.7612
0.6951
0.6346
0.5795
Total
4
82.18
75.03
68.51
62.56
57.12
631.63
977.03
Topic Bond Markets
5
4x1
82.18
150.07
205.53
250.22
285.59
3789.81
4763.40
Page 54
Macaulay Duration =
4763
= 4.87
977

Modified Duration =
Macaulay Duration
(1 + k)
4.875
(1 + 9.52%)
= 4.45//
Step 4 Change in bond price
New bond price
Prof Manish Ramuka
= - [Modified Duration] *[% Change in Yield]

= -4.45 * 0.5
= -2.225%//
= 976.95 2.225%
= 955.21
Topic Bond Markets
Page 55
Problem #56
Consider a 14%, 20 year bond trading at Rs. 960. It is callable at a premium of 10% at the
end of 5 years. If not called it is redeemable on maturity at par. Find yield duration and
price volatility.
Solution
Step 1 Calculate Yield to Call
Coupon Rate = 14%
Maturity = 20Yrs
Bond is callable in 5 Yrs
Price
960
= C X PVIFA (K%, n)
= 140 * PVIFA (YTC, 5)
+
+
FV X PVIF (K%, n)
1000 * PVIF (YTC, 5)
First lets find if equation matches at YTM of 15.5%

Price
= 140 * PVIFA (15.5%, 5)
+
= 140 * 3.3128
+
= 950
1000 * PVIF(15.5%, 5)
1000 * 0.4865
Calculating price @ YTM of 15%

Price
= 140 * PVIFA (15%, 5)
= 966.47
1000 * PVIF(15%, 5)

YTM = Lower % +
YTC
= 15%
966.47960
966.47950
(15.5% - 15%)
= 15.2%
Step 2: Calculate YTM
FP
C+
n
YTM Approximate =
F+P
2
YTM Approximate =
1000 960
20
1000 + 960
2
140 +
YTM Actual = 14.63%
Prof Manish Ramuka
Topic Bond Markets
Page 56
Step 3 Calculate Macaulay duration

nt=1
Macaulay Duration =
1
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
tc
n Bn
+
t
(1 + k) (1 + k)t
B0
2
Cash Flow
140
140
140
140
140
140
140
140
140
140
140
140
140
140
140
140
140
140
140
1140
Macaulay Duration =
3
PV Factor @ 9.52%
0.8724
0.7611
0.6640
0.5793
0.5053
0.4409
0.3846
0.3355
0.2927
0.2554
0.2228
0.1944
0.1696
0.1479
0.1291
0.1126
0.0982
0.0857
0.0748
0.0652
Total
4
122.14
106.55
92.96
81.10
70.75
61.72
53.85
46.98
40.98
35.75
31.19
27.21
23.74
20.71
18.07
15.76
13.75
12.00
10.47
74.35
960.00
5
4x1
122.14
213.10
278.87
324.38
353.74
370.33
376.92
375.80
368.83
357.52
343.10
326.53
308.60
289.94
271.01
252.19
233.76
215.93
198.85
1486.92
7068.46
7068
= 7.363
960

Modified Duration =
Macaulay Duration
(1 + k)
7.363
(1 + 14.62%)
= 6.42//
Prof Manish Ramuka
Topic Bond Markets
Page 57
Category #4: Immunization

Problem #57
Consider a Pension Fund which has the following Liability Structure:
Years
Liability (Amount in Rs.)
1
80
2
110
3
60
Opportunity Cost of Capital = 15% pa.
Hence, the pension fund wants to invest funds in such a manner that its liabilities are
exactly met despite change in Interest Rate.
Solution
In order to immunize any liability using bond portfolio in such a way that change in interest
rates will have no impact on the value of the portfolio, the duration of the portfolio should
be equal to the investment horizon or duration of the liability
Calculating duration of our liability
nt=1
Macaulay Duration =
1
Yrs
1
2
3
2
CF
80
110
60
Macaulay Duration =
tc
n Bn
+
(1 + k)t (1 + k)t
B0
3
Discount Factor
0.8696
0.7561
0.6575
Total
4=3x2
PV
69.57
83.18
39.45
192.19
5
4X1
69.57
166.35
118.35
354.27
354.27
= 1.84
192.19
Hence we should create a portfolio of bonds in such a way that its duration is equal to
1.84yrs. Hencce the portfolio will be immunized to changes in interest rate movements.
Prof Manish Ramuka
Topic Bond Markets
Page 58
Problem #58
Consider a pension fund with the following liability structures:
Years
Liability amount (Rs. In lakhs)
1
30
2
40
3
20
4
50
Opportunity cost of funds = 12% pa. The fund manager has short listed 2 ZCBs bond X
and bond Y, with maturities of 2 years and 5 years respectively. Both are presently yielding
12%.
(a) What proportions of funds need to be invested in these bonds for immunization.
Also compute the face value of each bond.
Solution
be equal to the duration of the liability
Step 1: Calculate duration of liability
nt=1
Macaulay Duration =
1
Yrs
1
2
3
4
2
CF
30
40
20
50
Macaulay Duration =
tc
n Bn
+
(1 + k)t (1 + k)t
B0
3
Discount Factor
0.8929
0.7972
0.7118
0.6355
Total
4=3x2
PV
26.79
31.89
14.24
31.78
104.68
5
4X1
26.79
63.78
42.71
127.10
260.37
260.37
= 2.49
104.68
Step 2 Calculate the duration of each bond
Since both the bonds are zero coupon bonds their duration will be equal to their maturity
Prof Manish Ramuka
Topic Bond Markets
Page 59
Step 3: Calculate the proportion of each bond in the portfolio

Let X and Y denote the proportion of weights of Bond X and Y respectoively
2X+5Y = 2.49
X+Y = 1
Solving above 2 equations simultaneously we get
X=83.67%
Y=16.63%
Prof Manish Ramuka
Topic Bond Markets
Page 60
Problem #59
Mr. Rohit Sharma is required to make the following payments at the end of each year for
the next 6 years.
Year
1
2
3
4
5
6
Payment
25.50
19.25
18.25
17.50
19.50
17.50
(Rs Lakhs)
He is planning to immunize his liability by investing in the following into bonds.
Bond X:
11% Coupon bond of face value Rs. 1,000 maturing after 5 years,
redeemable at 5% premium and currently traded at Rs. 966.38.
Bond Y:
13% Coupon bond of face value Rs. 1,000 maturing after 3 years,
redeemable at 5% discount and currently traded at Rs. 988.66.
Required:
a. If the interest rate is 12%, calculate the proportions of funds to be invested in
bonds X and Y, so that Mr. Sharmas payments are immunized.
Answer DL = 2.99 Yrs, Wx = .23, Wy = .77
Solution
nt=1
Macaulay Duration =
1
Yrs
1
2
3
4
5
6
2
CF
25.5
19.25
18.25
17.5
19.5
17.5
Macaulay Duration =
tc
n Bn
+
t
(1 + k) (1 + k)t
B0
3
Discount Factor
0.8929
0.7972
0.7118
0.6355
0.5674
0.5066
Total
4=3x2
PV
22.77
15.35
12.99
11.12
11.06
8.87
82.16
5
4X1
22.76786
30.69196
38.96997
44.48627
55.32412
53.19627
245.44
245.44
= 2.99
82.16
Prof Manish Ramuka
Topic Bond Markets
Page 61
Step 2 Calculate the YTM of each bond using approximate formula

FP
C+ n
YTM Approximate =
F+P
2
Bond X
YTM X =
1050 966.38
5
= 12.72%
1050 + 966.38
2
110 +
Bond Y
YTM Y =
950 988.66
3
= 11.99%
950 + 988.66
2
130 +
Step 3: Calculate the duration of each bond

Bond X
1
Yrs
1
2
3
4
5
2
CF
110
110
110
110
1160
Macaulay Duration =
Bond Y
1
Yrs
1
2
3
2
CF
130
130
1080
Macaulay Duration =
Prof Manish Ramuka
3
Discount Factor
0.8871
0.7870
0.6981
0.6193
0.5494
Total
4=3x2
PV
97.58
86.57
76.79
68.13
637.31
966.38
5
4X1
98
173
230
273
3187
3960.16
4=3x2
PV
116.08
103.65
768.93
988.66
5
4X1
116
207
2307
2630.18
3960.16
= 4.1
966.38
3
Discount Factor
0.8929
0.7973
0.7120
Total
2630.18
= 2.66
988.66
Topic Bond Markets
Page 62

4.1X+2.66Y = 2.99
X+Y = 1
X=23%
Y=77%
Prof Manish Ramuka
Topic Bond Markets
Page 63
Problem #60
Consider a pension with the following liability structure:
Years
Liability amount (Rs in lakhs)
1
40
2
70
3
60
Opportunity cost 14% p.a.
Short listed bonds 2 year and 7 year ZCB, both yielding 14%. Find out the proportion of
funds to be invested in each bond for immunization?
Solution
tc
n Bn
nt=1
+
t
(1 + k) (1 + k)t
Macaulay Duration =
B0
1
2
3
Yrs
CF
Discount Factor
1
40
0.8772
2
70
0.7695
3
60
0.6750
Total
Macaulay Duration =
4=3x2
PV
35.09
53.86
40.50
129.45
5
4X1
35.09
107.73
121.49
264.31
264.31
= 2.04
129.45
Step 2 Calculate the duration of each bond
Since both the bonds are zero coupon bonds their duration will be equal to their maturity
2X+7Y = 2.04
X+Y = 1
X=99.2%
Y=0.8%
Prof Manish Ramuka
Topic Bond Markets
Page 64
Problem #61
The following corporate bonds are considered for investment by the portfolio manager. His
aim is to immunize the liability due in six years. All bonds have face value of Rs1000.
Bond
Maturity
Coupon
Duration years
(Years)
%
Arvind Mills
10
8
7.35
BILT
8
9
6.15
Cipla
5
7
4.30
If the portfolio manager wishes to invest 50% in Arvind Mills, What is the percentage of
total amount that can be invested in the other two bonds to immunize the portfolio?
Solution
In order to immunize the portfolio the duration of the portfolio should be equal to the
investment horizon
This implies
Portfolio duration = 6
i.e.
+ +
Solving we get
0.5 X 7.35
+
X 6.15
X 4.3
Also
+ +
i.e.
+ =0.5
We have 2 simultaneous equation solving we get
=
=
9.5%
40.5% //
Prof Manish Ramuka
Topic Bond Markets
Page 65
Category #5: Forward Rates & Spot Rates Calculation
Problem #62
If the 1 year spot is 5%, 1 year forward, starting one year from today is 6.5% and 1 year
forward starting two years from today is 8%, what is three year spot rate?
Solution
1 = 5%
11 = 6.5%
12 = 8%
3 = ?
0
5
6.5
8
|-----------------------|-----------------------|--------------------------|
-------------------------------X----------------------------------
(1 + )3
= (1 + 5%) * (1 + 6.5%) * (1 + 8%)

= 6.49%
Prof Manish Ramuka
Topic Bond Markets
Page 66
Problem #63
Solution
Current 1 year rate =
1 year forward rate = (12-0.75)
2 year forward rate = (11.25-0.50)
= 12%
= 11.25%
= 10.75%
(1 + S2 )2 = 1 + 1f0 1 + 1f1
(1 + S2 )2 = 1 + 12% (1 + 11.25%)
1 + S3
1 + S3
3
3
= 1 + 1f0 1 + 1f1 1 + 2f1

= 1.12 1.1125 (1.1075)
Price =
C
C
C + FV
+
+
2
(1 + S1 ) (1 + S2 )
1 + S3 3
Price =
90
90
1090
+
+
(1 + 12%)
1 + 12% (1 + 11.25%)
1.12 1.1125 (1.1075)
=
942.48 //
Since
1.02
Price
942.48*102
961.33 //
Prof Manish Ramuka
Topic Bond Markets
Page 67
Problem #64
Solution
a)
Forward rate 1 year from today
(1 + S2 )2 = 1 + S1 1 + 1f1
(1 + 11.25%)2 = (1 + 10.5%) (1 + X%)
1.11252
1 + X% =
= 12%
1.105
Similarly
(1 + S3 )3 = 1 + S1 1 + 1f1 (1 + 2f1 )
1 + 12% 3
1 + 2f1 =
(1.105 1.12)
2f1 = 13.52%
b)
If bond is fairly priced then it implies its coupon rate is 12%.
This implies if interest rates increase by 50 basis points then YTM will be 12.5%
Calculate the price of bond at YTM of 12.5%
Price
= 120 * PVIFA(12.5%, 5) + 1000 * PVIF(12.5%, 5)
= 982.19
% Change in bond price =
Prof Manish Ramuka
982.19 1000
= . %
1000
Topic Bond Markets
Page 68
Problem #65
Following are the annual interest rates of a security :
Spot rate on one year
Forward rate after one year for one year
Forward rate after two years for one year
8.5%
9.50%
13.56%
What is the yield of the security for three years?

Solution
(1 + S3 )3 = 1 + S1 1 + 1f1 (1 + 2f1 )
(1 + S3 )3 = 1 + 8.5% 1 + 9.5% (1 + 13.56%)
= . %
Prof Manish Ramuka
Topic Bond Markets
Page 69
Problem #66
A bond issued by ABC Ltd. is selling presently at a face value of Rs100 and pays coupon at
the rate of 13% p.a. in arrears, which will be redeemed at Rs113 after five years. The n
years spot rate of interest is (8.56+ n/6)% where, n=1, 2,3,4 and 5. The term structure of
interest rates is flat and pure expectation theory holds good.
You are required to calculate:
The value of the bond at time 0
The duration of the above bond
Change in bond price for 50 basis point increase in interest rates.
(Answer: a. Rs122.79; b. Duration 4.1 years; c. New Price =Rs120.2
(Hint: a. Five different yields to be used for finding the price)
Solution
Sn = 8.56 +
n
6
Year
1
2
3
4
5
Spot Rate
8.73
8.89
9.06
9.23
9.39
1) Calculate Bond Price

Bond Price = Present Value of Future Cash Flows
13
1.0873
Bond Price
Bond Price
= 122.5
+
1
13
1.0889
+
2
13
1.0906
+
3
13
1.0923
+
4
13 + 113
1.0939 5
2) Calculate YTM using approximate formula

FP
C+
n
YTM Approximate =
F+P
2
YTM
113 122.5
5
113 + 122.5
2
13 +
= . %
Prof Manish Ramuka
Topic Bond Markets
Page 70
3) Calculate Macaulay Duration

nt=1
Macaulay Duration =
1
Year
1
2
3
4
5
tc
n Bn
+
(1 + k)t (1 + k)t
B0
2
Cash Flow
13
13
13
13
126
Macaulay Duration =
3
PV Factor @ 9.42%
0.9139
0.8352
0.7633
0.6976
0.6376
Total
4
11.88
10.86
9.92
9.07
80.33
122.06
5
4x1
11.88
21.72
29.77
36.28
401.66
501.30
501.3
122.06
= 4.11//
4) Calculate Modified Duration

Modified Duration =
Macaulay Duration
(1 + k)
4.11
(1 + 9.42%)
= 3.75//
5) Change in bond [price
New bond price
Prof Manish Ramuka
=
=
=
= 122.5 1.875%
= 120.20

-3.75 * 0.5
-1.875%//
Topic Bond Markets
Page 71
Problem #67
Consider three pure discount bonds with maturities of one, two and three years and prices
of Rs930.23, Rs923.79 and Rs919.54 respectively. Each bond has a face value of Rs1000.
What are the 1 year, 2 year and 3 year spot rates?
Solution
For zero coupon bonds bond price is calculated using following formula
FV
Price =
1 + Sn n
1 year bond
1000
930.23 =
(1 + S1 )
Solving we get S1 = 7.5%
2 year bond
1000
(1 + S2 )2
923.79 =
3 year bond
1000
(1 + S3 )3
919.54 =
Problem #68
Given the following spot rates for various periods of time from today, calculate forward
rates from years one to two, two to three and three to four.
S1 = 5%, S2 = 5.5%, S3 = 6.5%, S4 = 7%
Solution
1 year forward rate
(1 + S2 )2 = 1 + S1 1 + 1f1
1 + 5.5% 2 = 1 + 5% 1 + 1f1
(1.055)2
(1 + 1f1 ) =
1.05
= %
2 year forward rate
(1 + S3 )3 = 1 + S2 2 (1 + 2f1 )
(1 + 6.5%)3 = (1 + 5.5%)2 (1 + 2f1 )
= . %
3 year forward rate
= . %
Prof Manish Ramuka
Topic Bond Markets
Page 72
Problem #69
Give the following forward rates for respective years; calculate the spot rates for years one,
two, three and four.
Year
Forward Rate
1
10.0%
2
9.5%
3
9.0%
4
8.5%
Solution
(1 + S2 )2 = 1 + S1 1 + 1f1
S2 =
1 + 10% 1 + 9.5 1
S2 = 9.75%
(1 + S3 )3 = 1 + S1 1 + 1f1 (1 + 2f1 )
3
S3 =
1 + 10% 1 + 9.5% 1 + 9% 1
S3 = 9.5%
(1 + S4 )4 = 1 + S1 1 + 1f1 1 + 2f1 (1 + 3f1 )
4
S4 = 1.1 1.095 1.09 1.085
S4 = 9.2%
Prof Manish Ramuka
Topic Bond Markets
Page 73
Problem #70
Assume that the government has issued three bonds. The first which pays Rs1000 one year
from today is selling at Rs909.09. The second which pays Rs100 one year from today and
Rs1100 a year later is selling at Rs991.81. The third which pays Rs100 one year from today,
Rs100, one year later and Rs1100 one year after that, is selling for Rs997.18. What are the
forward rates for one, two and three years from today?
Solution
FV
Price =
1 + Sn n
1 year bond
1000
909.09 =
(1 + S1 )
Solving we get S1 = 10%
2 year coupon bond price is given as
Price =
991.81 =
C
C + FV
+
(1 + S1 ) (1 + S2 )2
100
1100
+
(1 + 10%) (1 + S2 )2

C
C
C + FV
Price =
+
+
(1 + S1 ) (1 + S2 )2
1 + S3 3
997.18 =
100
100
1100
+
+
(1 + 10%) (1 + 10.5%)2 (1 + S3 )3

1 years forward Rate calculation
(1 + S2 )2 = 1 + S1 1 + 1f1
(1 + 10.5%)2 = 1 + 10% 1 + 1f1
= %
(1 + S3 )3 = 1 + S2 2 (1 + 2f1 )
(1 + 10.09%)3 = (1 + 10.5%)2 (1 + 2f1 )
= . %
Prof Manish Ramuka
Topic Bond Markets
Page 74
Problem#71
Consider the following data:
Bonds
Years (maturity)
Face value
Coupon rate
A
1
1000
0
B
2
1000
10%
C
3
1000
12%
Derive the term structure.
Answer Spot rates for years 1, 2 & 3 = 7.07%, 11.07%, 11.84%
Market price
934
985
1010
Solution
FV
Price =
1 + Sn n
S1 =
1000
1 = 7.07%
934

Price =
985 =
C
C + FV
+
(1 + S1 ) (1 + S2 )2
100
1100
+
(1 + 7.07%)
1 + S2
Solving we get S2 = 11.07

C
C
C + FV
Price =
+
+
2
(1 + S1 ) (1 + S2 )
1 + S3 3
1010 =
120
120
+
(1 + 7.07%)
1 + 11.07
+
2
1120
1 + S3
Solving we get S3 = 11.84
Prof Manish Ramuka
Topic Bond Markets
Page 75
Problem#72
A bond issued by ABC Co. is selling presently at the face value of Rs. 100 and pays coupon at
the rate of 10% p.a. in arrears and will be redeemed at Rs. 110 after 3 years.
The n year spot rate interest, Yn is given by Yn (%) = 9.0 + n/10 for n = 1,2 and 3.
Assuming the pure expectations theory holds good, calculate:(i)
The implied one year forward rates applicable at times t = 1 and t = 2
(ii)
The value of the bond at time t = 0
Answer - = 9.3%, = 9.5%, IV = 109.46
Solution
Sn = 9.0 +
n
10
Year
1
2
3
Spot Rate
9.1
9.2
9.3

Price =
C
C
C + FV
+
+
(1 + S1 ) (1 + S2 )2
1 + S3 3
10
1.091
Bond Price
Bond Price
= 109.45
10
1.092
120
1.093
2)
1 + S2 2 = 1 + S1 1 + 1f1
1 + 9.2% 2 = 1 + 9.1% 1 + 2f1
Solving we get
1f1 = 9.3%
(1 + S3 )3 = 1 + S1 1 + 1f1 (1 + 2f1 )
(1 + 9.3)3 = 1 + 9.1% 1 + 9.3% (1 + 2f1 %)
Solving we get
2f1 = 9.5%
Prof Manish Ramuka
Topic Bond Markets
Page 76
Problem #73
Consider the sovereign yield curve.
Given rn = 9 + n/10
Find out the intrinsic value of a 12% Rs. 1000 face value 3 year government bond.
Solution
Sn = 9.0 +
n
10
Year
1
2
3
Spot Rate
9.1
9.2
9.3

Price =
C
C
C + FV
+
+
2
(1 + S1 ) (1 + S2 )
1 + S3 3
120
1.091
Bond Price
Bond Price
= 1068.3
Prof Manish Ramuka
120
1.092
1120
1.093
Topic Bond Markets
Page 77
Problem #74
Assume you observe the following three coupon bond prices and remaining cash flows
(coupons are paid annually and this years coupon has already been paid
Bond A is currently trading at a price of 107, has a face value of 100 and 10% coupon
and three years to maturity.
Bond B is currently trading at a 105, has a face value of 100 and 10% coupon and two
years to maturity.
Bond C is currently trading at a price of 100, has a face value of 100 and 10% coupon and
1 year to maturity.
Find out the term structure of interest rates by the method of bootstrapping. Also, compute
the 1 Yr forward rates.
Answer - = = 10%, = 4.25%, = 7.54%, = 12.12%, = 10%, = 7.09%,
= 7.24%
Solution
S1 =
1100
1 = 10%
100

C
C + FV
Price =
+
(1 + S1 ) (1 + S2 )2
10
110
105 =
+
(1 + 10%)
1 + S2 2
C
C
C + FV
Price =
+
+
2
(1 + S1 ) (1 + S2 )
1 + S3 3
10
10
110
107 =
+
+
2
(1 + 10%)
1 + 7.09%
1 + S3

1 + S2 2 = 1 + S1 1 + 1f1
1 + 7.09% 2 = 1 + 10% 1 + 1f1
Solving we get
1f1 = 4.256%
(1 + S3 )3 = 1 + S1 1 + 1f1 (1 + 2f1 )
(1 + 7.24)3 = 1 + 10% 1 + 4.256% (1 + 2f1 %)
Solving we get
2f1 = 7.54%
Prof Manish Ramuka
Topic Bond Markets
Page 78
Problem #75
ABC Ltd. is coming out with an issue of two series of zero coupon bonds maturing in 4 and
5 years. Face value of both the bonds is Rs. 1000. Market price of similar traded bonds is Rs.
925 and Rs. 900 respectively. Mr. Tiwari is considering investing in these bonds.
You are required to calculate one year interest rates after 4 years.
Answer - = 4.18%
Solution
925 1 + S4 4 = 1000
Solving we get
S4 = 1.968%
900 1 + S5 5 = 1000
Solving we get
S5 = 2.13%
1 + S5 5 = 1 + S4 4 (1 + 4f1 )
Solving we get 4f1 = 2.78%
Prof Manish Ramuka
Topic Bond Markets
Page 79
Problem #76
Suppose a zero-coupon bond maturing one year from now costs Rs. 90, a zero-coupon bond
maturing two years from now costs Rs. 80, and a zero-coupon bond maturing three years
from now costs Rs. 70.
Calculate:
1. The zero-coupon yields for one-year, two-year and three-year zero-coupon bonds;
2. The implied 1 year forward interest rates.
Answer - = 11.11%, = 11.8%, = 12.6%, = 11.11%, = 12.49%, =
14.22%, = 28.49%
Solution
FV
Price =
1 + Sn n
1 year Zero Coupon Bond
100
S1 =
1 = 11.11%
90
100
80 =
1 + S2 2
100
70 =
1 + S3 3
1 year forward Rate calculation
1 + S2 2 = 1 + S1 1 + 1f1
1 + 11.8% 2 = 1 + 11.11% 1 + 1f1
Solving we get
1f1 = 12.49%
(1 + S3 )3 = 1 + S1 1 + 1f1 (1 + 2f1 )
(1 + 12.6)3 = 1 + 11.11% 1 + 12.49% (1 + 2f1 %)
Solving we get
2f1 = 14.22%%
Prof Manish Ramuka
Topic Bond Markets
Page 80
Problem #77
From the following data for Government securities, calculate the forward rates:
Face Value (Rs.)
Interest rate
Maturity (Year)
Current price (Rs.)
1,00,000
0%
1
91,500
1,00,000
10%
2
98,500
1,00,000
10.5%
3
99,000
Solution
S1 =
1,00,000
1
91,500

Price =
98,500 =
C
C + FV
+
(1 + S1 ) (1 + S2 )2
10,000
1,10,000
+
(1 + 9.23%)
1 + S2 2

C
C
C + FV
Price =
+
+
2
(1 + S1 ) (1 + S2 )
1 + S3 3
99,000 =
10,500
10,500
+
(1 + 9.23%)
1 + 10.96%
1,10,500
1 + S3 3

1 + S2 2 = 1 + S1 1 + 1f1
1 + 10.96% 2 = 1 + 9.23% 1 + 1f1
Solving we get
1f1 = 12.72%
(1 + S3 )3 = 1 + S1 1 + 1f1 (1 + 2f1 )
(1 + 10.97)3 = 1 + 9.23% 1 + 12.72% (1 + 2f1 %)
Solving we get
2f1 = 10.99%
Prof Manish Ramuka
Topic Bond Markets
Page 81
Problem #78
Consider the following date for Government securities:
Face value
Interest (Rate %)
Maturity (Years)
1,00,000
0
1
1,00,000
10.5
2
1,00,000
11.0
3
1,00,000
11.5
4
Calculate the forward interest rates.
Current Price (Rs.)

91,000
99,000
99,500
99,900
Solution
S1 =
1,00,000
1
91,000

Price =
99,000 =
C
C + FV
+
(1 + S1 ) (1 + S2 )2
10,500
1,10,500
+
(1 + 9.89%)
1 + S2 2

C
C
C + FV
Price =
+
+
2
(1 + S1 ) (1 + S2 )
1 + S3 3
99,500 =
11,000
11,000
+
(1 + 9.89%)
1 + 11.15%
+
2
1,11,000
1 + S3 3

C
C
C
Price =
+
+
2
(1 + S1 ) (1 + S2 )
1 + S3
99,900 =
11,500
11,500
+
(1 + 9.89%)
1 + 11.15%
C FV
(1 + S4 )4
11,500
1 + 11.26%
1,11,500
1 + S4 4
Prof Manish Ramuka
Topic Bond Markets
Page 82

1 + S2 2 = 1 + S1 1 + 1f1
1 + 11.15% 2 = 1 + 9.89% 1 + 1f1
Solving we get
1f1 = 12.42%
(1 + S3 )3 = 1 + S1 1 + 1f1 (1 + 2f1 )
(1 + 11.26)3 = 1 + 9.89% 1 + 12.42% (1 + 2f1 %)
Solving we get
2f1 = 11.48%
(1 + S4 )4 = (1 + S3 )3 1 + 3f1
1 + 11.64% 4 = 1 + 11.26% 3 1 + 3f1 %
3f1 = 12.78%
Prof Manish Ramuka
Topic Bond Markets
Page 83
Category #6: Clean Price & Dirty Price

Problem #79
Solution
a)
YTM as of January 1, 2000
Since the bonds were sold @ Par
YTM
=
=
CR
10%
b)
Step1: Calculate clean price on next coupon date i.e on 30/June/2008
k
k
2
2
Clean Price = 50 PVIFA ((
12
12
)%, 2 7.5) + 1000 PVIF ( )%, 2 7.5)
2
2
Clean Price = 902.87

Step2: Calculate Dirty Price on i.e on 30/June/2008
Dirty Price = Clean Price + Coupon
= 902.87+50
= 952.87
Step 3: Calculate Dirty Price on 1/March/2008
Dirty Price =
952.87
= 916.22
1 + 6% 4/6
Prof Manish Ramuka
Topic Bond Markets
Page 84
Step 4: Calculate Clean Price on 1/March/2008

Dirty Price = Clean Price + Accrued Interest
Clean Price = Dirty Price Accrued Interest
Clean Price = 916.22 50*(2/6)
Prof Manish Ramuka
Topic Bond Markets
Page 85
Problem #80
Consider a bond with the following features:
Face value Rs. 1, 00,000
Coupon rate 12% payable at the end of December each year
Required return 15%
Valuation date 1st April 2009.
Redemption, i.e. Maturity date 31.12.2015
Current market price 92.55%. Redemption at par on maturity.
Find out the intrinsic value, that is full price of the bond and split it into the accrued
interest and clean price components. Give your investment advice.
Answer Clean Price & Dirty price today = Rs. 90628, 87628
Solution
Step1: Calculate clean price on next coupon date i.e on 31/Dec/2009
Clean Price = 12,000*PVIFA(15%,6) + 1,00,000*PVIF(15%,6)
Clean Price = 88,646.55
Step2: Calculate Dirty Price on i.e on 31/Dec/2009
= 88,646.55+12,000
= 1,00,646.55
Step 3: Calculate Dirty Price on 1/Apr/2009
Dirty Price =
1,00,646.55
= 90,630.74
1 + 15% 9/12
Step 4: Calculate Clean Price on 31/March/2008

Clean Price = 90,630.74 12,000*(3/12)
Clean Price = 87,630.74
However the actual price quoted in the market is 92,550 which is greater than intrinsic
value. So the bond is trading rich and investor should go short.
Prof Manish Ramuka
Topic Bond Markets
Page 86
Problem #81
Consider a bond with the following features:
Face value Rs. 1000
Coupon rate 14% payable semi-annually on end June and end December.
Required rate 12% BEY.
Maturity date 31st December 2022.
Valuation date 1st October 2010.
Market quoted price = 103%.
Give your investment advice by computing the clean price of the bond.
Answer Clean price & Dirty price today = Rs. 1161.79, 1126.79
Solution
Step1: Calculate clean price on next coupon date i.e on 31/Dec/2010
k
k
2
2
Clean Price = 70 PVIFA (6%, 24) + 1000 PVIF (6%, 24)
Step2: Calculate Dirty Price on i.e on 31/Dec/2010
= 1125.49+70
= 1195.5
Step 3: Calculate Dirty Price on 01/Oct/2010
Dirty Price =
1195.5
= 1161.16
1 + 6% 3/6
Step 4: Calculate Clean Price on 01/Oct/2010

Clean Price = 1161.16 70*(3/6)
Since the market price 1030 is less than intrinsic value the bond is trading cheap and
investor should go long
Prof Manish Ramuka
Topic Bond Markets
Page 87
Category #7: Bond Refunding Decision

Problem #82
Solution
Details of old bond
Coupon Rate
FV
Unamortized cost
= 12%
= 300mn
= 9mn
New bond details

CR
FV
Issuance cost
= 10%
= 300mn
= 6mn
Call premium of 4% on old bond

Tax rate
Discount Rate
= 30%
= 7%
Cash outflow for calling old bonds
= 300 + 4% of 300
= 312mn
Cash outflow for Issuance cost of new bond

Cash inflow from new bond
= 6mn
= 300mn
Now lets calculate savings & taxes

Premium cost & unamortized cost of old bonds will be deducted now in income statement
which will lead to tax savings.
Tax savings
= (9 + 12) * 0.3
= 6.3mn
There will be savings on coupon also as new coupon is leaser compared to old
Difference in coupon
= 300 (12% - 10%)
= 6mn
Prof Manish Ramuka
Topic Bond Markets
Page 88
However because of savings on coupon tax payment will also go up as a result of which net
savings will be net of tax loss
= 6mn * (1 0.3)
= 4.2mn //
4.2mn of saving every year for next 6 years
PV of 4.2mn @ 7% for 6 yrs
= 4.2 * PVIFA (7%, 6)

= 20.02mn //
Now here is tricky part

Because of new bonds issuance cost of 6mn there will be tax benefits.
New bond will be amortized (i.e. its issuance cost will be amortized over next 6 years
Amortized cost
=
=
=
Savings on tax due to amortization cost

=
=
6mn
6 yrs
1mn
0.3 * 1mn * PVIFA (7%, 6)

1.42mn
However the unamortized cost of 9m of old bond is not there now

Hence loss in taxes because of that
9
= 0.3 * (PVIFA) (7%, 6)
6
= 2.14mn
Net savings
= 312 6 + 300 + 6.3 + 20.02 + 1.42 2.14

= 7.6mn //
Here there is net savings we should consider refunding of bonds.
Prof Manish Ramuka
Topic Bond Markets
Page 89
Problem #83
Solution
Time to maturity
Outstanding Value
Coupon Rate
= 10 Years
= 2 Cr
= 11%
New Coupon Rate

Unamortized issue cost
Insurance cost of New bonds
Call Premium
= 9%
= 3L
= 2.5L
= 5%
a)
b)
c)
d)
Proceeds from issuance of new bonds

Issuance Cost
Refunding of old bonds
Premium on old bond
= + 2 Cr
= - 25 Lacs
= - 2 Cr
= 5% of 2 Cr
= - 10L
e) Tax savings due to unamortized portion & Premium
= 30% [10L + 3L]
= + 3.9L
f) Savings due to lower coupon rate
= 2 Cr * [11% - 9%] * (1 30%)
= 2.8 Lacs per Year
PV of total savings
= 2.8 * PVIFA (7%, 10)
= 19.66602
g) Savings on tax due to amortization of issuance cost
=
2.53
10
* 0.3 x PVIFA (7%, 10)
= -0.1054L
Total savings
= 2 Cr 2.5L 2 Cr 10L + 3.9L +19.66L 0.1054L

= 10.9546 Lacs
Hence refunding should be considered.
Prof Manish Ramuka
Topic Bond Markets
Page 90
Problem #84
Prof Manish Ramuka
Topic Bond Markets
Page 91
Category #8: Convertible Bond

Problem #85
Solution
FV
Price
CR
Conversion rate
CMP
Share Price
=
=
=
=
=
=
1000
1350
10.5%
14 Shares
1475
80
Conversion Premium is % increase in price required from CMP to reach to conversion price
Conversion price
Conversion Price
=
=
Conversion Premium =
Conversion premium =
=
Prof Manish Ramuka
Market Price of Bond

Conversion Rate
1475
14
105.3571
(Conversion Price Current Share Price)
Current Share Price
105.3571 80
80
31.7% //
Topic Bond Markets
Page 92
Problem #86
Solution
Coupon Rate
Conversion ratio
FV
Maturity
=
=
=
=
12
20
100
5 yrs
Current Price of bond @ 8% YTM

Price
=
=
12 * PVIFA (8%, 5) + 100 * PVIF (8%, 5)

115.97
We should convert whenever we get more value than 115.97

When share price
Net worth of shares
=
=
=
4
20*4
80
When share price

Net worth of shares
=
=
5
100
When share price

Net worth of shares
=
=
6
120
Hence we should convert only when share price is 6 //
Prof Manish Ramuka
Topic Bond Markets
Page 93
Problem #87
Solution
Stock value of bond =
=
=
Downside Risk =
Current Market Price * Conversion ratio

20*12
240
(Market Price Straight Value)

Straight Value
=
=
265235
235
12.77%
=
=
Conversion Parity
=
=
=
Prof Manish Ramuka

Current Share Price
13.2512
12
10.42%
Current Market Price of Bond
Conversion Ratio
265
20
13.25
Topic Bond Markets
Page 94
Problem #88
Solution
Conversion ratio
Conversion Premium
10
Current Share Price
OR
Conversion Premium
=
=
=
(Current Market Price of Bond Conversion Value)

Conversion Value
5400 (43010)
(43010)
25.58% //
Conversion Value Stock Value
= Current Market Price Conversion Ratio

=
430*10
=
4300 //
Prof Manish Ramuka
Topic Bond Markets
Page 95
Problem #89
A convertible bond with a face value of Rs1,000 has been issued at Rs1, 300 with a coupon
rate of 12%. The conversions rate is 20 shares per bond. The current market price of the
bond is Rs1,500 and that of stock is Rs60. What is the conversion value premium?
Solution
Conversion price =

Conversion Rate
Conversion price =
1500
= 75
20

Current Share Price
(75 60)
100
60
Conversion Premium = %
Prof Manish Ramuka
Topic Bond Markets
Page 96
Problem #90
Consider the data regarding convertible bonds by M.K. Enterprise:Par Value
= Rs. 1000
Coupon rate
= 9%
Market price of the Convertible bond
= Rs. 925
Conversion ratio
= 25
Estimated Straight value of the bond
= Rs. 730
Price of common stock
= 30
Calculate each of the following:a. Conversion Value
b. Market Conversion price
c. Conversion premium per share
d. Conversion premium ratio
e. Premium over straight value
Solution
a)

=
30*25
=
750//
b)
Conversion price =

Conversion Rate
Conversion price =
925
= 37
25
c)

Current Share Price
(37 30)
100 = 23.33%
30
d)
Premium over straight value =
(Market Price of Bond Straight Value of Bond )

Straight Value of Bond
(925 730)
100 = 26.71%
730
Prof Manish Ramuka
Topic Bond Markets
Page 97
Problem #91
The following data is related to 8.5% Fully Convertible (into Equity shares) Debentures
issued by JAC Ltd. At Rs. 1000
Market Price of Debenture
Conversion ratio
Straight value of Debenture
Market Price of equity share on the date of Conversion
Rs. 900
30
Rs. 700
Rs. 25
You are required to calculate:

a. Conversion Value of Debenture
b. market Conversion Price
c. Conversion premium per share
d. Ratio of Conversion premium
e. Premium over straight value of debenture
Solution
a)

=
25*30
=
750//
b)
Conversion price =

Conversion Rate
Conversion price =
900
= 30
30
c)

Current Share Price
(30 25)
100 = 20%
25
d)
(Market Price of Bond Straight Value of Bond )

Straight Value of Bond
(900 700)
100 = 28.57%
700
Prof Manish Ramuka
Topic Bond Markets
Page 98
Problem #91
Newchem Corporation has issued a fully convertible 10% debenture of Rs. 10,000 face
value, convertible into 20 equity shares. The current market price of the debentures is Rs.
10,800, whereas, the current market price of equity share price is Rs. 480.
You are required to calculate (i) the conversion premium and 9ii) the conversion value.
Solution
a)
Conversion price =

Conversion Rate
Conversion price =
10800
= 540
20
b)

Current Share Price
(540 480)
100 = 12.50%
480
c)
Prof Manish Ramuka

=
480*20
=
9600//
Topic Bond Markets
Page 99
Problem #92
Consider a Rs1000 FV, 5 year 10% Coupon OCD which is convertible into 4 shares of share
price Rs. 260.
Yield on similar Non Convertible Debenture is 12%
Option Value = Rs. 50
Find the IV of the OCD.
Solution
Investment Value
Investment Value
Investment Value

= 260 4 = 1040

= 100* PVIFA (12%, 5) + 1000* PVIF (12%,5)
= 927.88
Floor Value of Bond = Higher of ( Conversion Value, Investment Value)

Floor Value of Bond = Higher of (1040 , 927.88)
Floor Value of Bond = 1040
Intrinsic Value
Intrinsic Value
Prof Manish Ramuka
= Floor Value + Option Premium

= 1040 + 50
= 1090
Topic Bond Markets
Page 100
Problem #93
Consider the following OCD:FV = Rs. 100000
Coupon Rate = 12%
Conversion Rate = 20.1 (1Bond = 20 Shares)
Share Price = Rs. 5210
Maturity of the OCD = 5 Years
YTM on similar Bonds = 13%
If option value is 5% of the floor Value, Calculate the IV of the OCD.
Solution
Investment Value
Investment Value
Investment Value

= 5210 20 = 1,04,200

= 12000* PVIFA (13%, 5) + 100000* PVIF (13%,5)
= 96,436.4
Floor Value of Bond = Higher of ( Conversion Value, Investment Value)

Floor Value of Bond = Higher of (1,04,200, 96,436)
Floor Value of Bond = 1,04,200
Intrinsic Value
Intrinsic Value
Prof Manish Ramuka
= Floor Value + Option Premium

= 104,200 + 4%
= 1,09,410
Topic Bond Markets
Page 101
Category #9: Mixed

Problem #94
Solution
a)Current Yield
14
90
= 15.5%
For YTM we need to find X in following equation
90 = 14 * PVIFA (X, 5) + 100 * PVIF (X, 5)
We solve it by trial & error and then use interpolation to get to correct answer.
At 15%
Price = 96.64
At 18%
Price = 87.49
Interpolation is used as follow

YTM = Low % +
(High % Low %)
YTM = 15% +
96.6490
96.6487.49
* 3%
= 15% + 2.177%
= 17.17%
Prof Manish Ramuka
Topic Bond Markets
Page 102
b)Duration
Yrs
1
2
3
4
5
CF
14
14
14
14
114
PV Factor
0.8535
0.728
0.622
0.531
0.453
1x2x3
11.94
20.38
26.12
29.73
258.2
346.38
Duration = 3.847 Years

iii) Realized Yield
14 5 + 100
90
= (1 + X)5
1.8889 = (1 + X)5
Solving we get
X = 13.56%
Prof Manish Ramuka
Topic Bond Markets
Page 103
Problem #95
Solution
a)
5 Year Bond
= 80 * PVIFA (6%, 5) + 1000 * PVIF (6%, 5)
= 1083.96
% change in 5 Yrs bond = 8.3%
Price increase due to change in PV of Principal
= 1000 * [PVIFA (6%, 5) PVIF (8%, 5)]
= 1000 * [0.747 0.681]
= 66
So out of total change of Rs. 83.96, 66 comes due to principal
Hence
% change in bond price due to principal
66
=
83.96
= 78.6%
% change in bond price due to coupon = 21.4%
Prof Manish Ramuka
Topic Bond Markets
Page 104
20 Year bond
= 80 * PVIFA (6%, 20) + 1000 * PVIF (6%, 20)
= 1229.6
% change in 20 Yrs bond = 22.9%
% change in 20 yrs bond price due to principal
= 42.68%
% change in bond price due to coupon = 57.32%
b)
Yrs
1
2
3
4
5
6
Duration =
CF
70
70
70
70
70
1070
PV Factor @ 7%
0.935
0.873
0.816
0.763
0.713
0.666
1x2x3
65.45
122.22
171.36
213.64
249.55
4275.72
5097.94
5097.74
1000
= 5.097 Years
C)
If YTM increase to 10%
New Price
= 70 * PVIFA (10%, 6) + 1000 * PVIF (10%, 6)
= 868.85
New duration can be calculated as follows as only discounting factor will change
New Duration
4366 .45
868.85
= 5.2025 Years
Since duration is inversely proportion to YTM.
Prof Manish Ramuka
Topic Bond Markets
Page 105
Problem #96
Consider a 10% bond of face value of Rs1,000 and redeemable after 5 years at a premium
of 5% What is the total interest on interest earned by the investor at the end of the second
year, if the reinvestment rate is 12% ?
Solution
Coupon earned at the end of year 1
=
=
10% of 1000
100
If reinvestment rates increase to 12% then interest earned on interest = 12% of 100
= 12
Prof Manish Ramuka
Topic Bond Markets
Page 106
Problem #97
Consider a bond with Rs1000 face value, 10 years to maturity and 8% coupon. Bond is
selling at an YTM of 10% now. If the yield is expected to decline to 9% at the end of 4 years
and if we sell the bond then, what is the total absolute and percentage return earned, if
coupons were reinvested at 9.5% Segregate the absolute return into four components: a
gain because of passage of time, b. gain because of decrease in yield, c. coupons and d.
reinvestment income.
Solution
Step I
Fund PV of bond today
n = 10
FV = 1000
I/Y = 10%
PMT = 80
Bond Price = C * PVIFA (k%, n) + Bn * PVIF (k%, n)
PV of Bond = 80 PVIFA 10%, 10 + 1000 PVIF 10%, 10
= 877.1087
Step II
Value of bond at the end of year 4
n=6
FV = 1000
I /Y = 9
PMT = 80
Bond Price = C * PVIFA (k%, n) + Bn * PVIF (k%, n)
Bond value = 955.14
Step III
Coupon payments @ end of Year
1 = 80 1.0953 = 105.03
2 = 80 1.0952 = 95.9
3 = 80 1.0951 = 87.6
4 = 80 10.950 = 80
Total = 368.53
Total absolute returns = 368.53 + 955 877
= 446.56//
% =
446.56
877.1087
= 50.91%
Prof Manish Ramuka
Topic Bond Markets
Page 107
Step IV
Gain because of investment income
= 368.56 320
= 48.56
Step V
Gain because of coupons
= 80 4
= 320
Step VI
Gain because of decrease in yield
Price of bond w/o change in yield at the end of 4 years
= 80 PVIFA 10%, 6 + 1000 PVIF 10%, 6
= 912.89
Hence gain due to change in yield
= 955.14 912.89
= 42.25
Gain due to passage of time
= Absolute Returns Coupon Income Gain due to change in yield
Reinvestment income
Gain due to passage of time = 446.56 48.56 320 42.25
= . //
Prof Manish Ramuka
Topic Bond Markets
Page 108
Problem #98
Fill in the table below for the following zero-coupon bonds. The face value of each bond is
1,000.
Price
Maturity (Years)
Yield to Maturity
A
5
10%
312.00
20
b
315.00
c
8%
Solution
Solving for a
Bond Price = 0 + 1000 * PVIF(10%,5)
a = 1000 * 0.621
a = 621
Solving for b
312 =
1000
(1 + b)20
312 = 1000 * PVIF(b%,20)

We can either solve the above equation using interpolation or we can look at the PVIF table
for value of 0.312 for 20 yrs
Solving we get b=6%
Solving for c
315 =
1000
(1 + 8%)c
315 = 1000 * PVIF(8%,c)

We can either solve the above equation using interpolation or we can look at the PVIF table
for value of 0.315 for 8%.
Solving we get c=15yrs
Prof Manish Ramuka
Topic Bond Markets
Page 109
Problem #99
ABC Ltd. Recently issued 5-year bonds. The bonds pay an annual coupon rate of 10 percent.
The bonds are callable in 3 years at a call price equal to 5 percent premium to par value.
The par value of the bonds is 1,000. If the yield to maturity is 10 percent what is the price
of the bond today and what is yield to call?
Solution
However since the YTM and coupon rate is same the Bond Price today is same as face value
which is equal to 1000
In order to calculate YTC we can use approximate formula or we can use interpolation
Using approximate formula
FP
C+ n
YTC Approximate =
F+P
2
YTC Approximate =
1050 1000
3
1050 + 1000
2
100 +
YTC Approximate = . %
Prof Manish Ramuka
Topic Bond Markets
Page 110
Problem #100
Jagat Industries Ltd. (JIL) has raised 50 crore though an issue of 9% bond. Each bond has a
face value of 500 and 10 years term to maturity. As per the terms of the issue each bond is
redeemable in four equal installment starting from the end of 7th year. You are required to
find out price of the bond if YTM is 13%.
Solution
FV = 500; Coupon Rate = 9% ; n = 10yrs ; YTM = 13% ; Price=?
Amount Redeemend in 7th Yr =125; Pending Amount =375
Year (1)
Coupon Received
(2)
1
2
3
4
5
6
7
8
9
10
Total
(9% * 500) = 45
(9% * 500) = 45
(9% * 500) = 45
(9% * 500) = 45
(9% * 500) = 45
(9% * 500) = 45
(9% * 500) = 45
(9% * 375) = 33.75
(9% * 250) = 22.5
(9% * 125) = 11.25
Prof Manish Ramuka
Redemption
Amount (3)
PV Factor @
13% (4)
125
125
125
125
.8849
.7831
.6931
.6133
.5427
.4803
.4250
.3762
.3329
.2945
Topic Bond Markets
Present
Value (5)=
4*(3+2)
39.82
35.23
31.18
27.95
24.42
21.61
72.25
59.72
49.10
40.12
401
Page 111
Problem #101
The price of a bond just before a year of maturity is $ 5,000. Its redemption value is $ 5,250
at the end of the said period. Interest is $ 350 p.a. The Dollar appreciates by 2% during the
said period. Calculate the rate of return.
Solution
Absolute Returns =
Ending Value Beginning Value + Dividend/Interest

Beginning Value
Absolute Returns on $ =
5250 5000 + 350

100
5000
Absolute Returns on $ = 12%
Total Returns on Rs = 12%(1+2%) + 2%

Total Returns on Rs = 14.24%
Prof Manish Ramuka
Topic Bond Markets
Page 112

CA Final SFM Solve Questions On Bond Valuation by Prof GDTPE140

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CA Final SFM Solve Questions On Bond Valuation by Prof GDTPE140

Uploaded by

Copyright:

Available Formats

Bond Analysis

Prof Manish Ramuka

Topic Bond Markets

Category #1: Bond Price

Similarly we can calculate other bond prices

Prof Manish Ramuka

Topic Bond Markets

Find price of Bond when yield is 7%

Prof Manish Ramuka

Topic Bond Markets

= C * PVIFA (k%, n) + Bn * PVIF (k%,n)

= 1000 Since Yield is same as coupon

Step II: Find price of 2 bonds when rates changes to 6%

Step III : % Change in Price

Prof Manish Ramuka

Topic Bond Markets

= 75 PVIFA 10%, 3 + 1000 8 PVIF 10%, 3

Step 2 Compare it with actual market value

Prof Manish Ramuka

Topic Bond Markets

Prof Manish Ramuka

3.75*PVIFA (3%, 4) + 10000*PVIF (3%, 4)

Topic Bond Markets

Prof Manish Ramuka

Bond Price = 375 PVIFA ((

Bond Price = 375 3.546 + 10000 0.823

Bond Price = 9559.75

Prof Manish Ramuka

Topic Bond Markets

State the results for YTM, Coupon Rate and Maturity

Prof Manish Ramuka

Topic Bond Markets

= 30 * PVIFA (4%, 10) + 1000* PVIF (4%,10)

= 40 * PVIFA (3%, 10) + 1000* PVIF (3%,10)

= 40 * PVIFA (5%, 30) + 1000* PVIF (5%,30)

Prof Manish Ramuka

Topic Bond Markets

Prof Manish Ramuka

Topic Bond Markets

Prof Manish Ramuka

Topic Bond Markets

Intrinsic Value of Perpetual Bond =

Prof Manish Ramuka

Topic Bond Markets

Category #2: YTM

YTC is calculated as follows

1130 * PVIF (x%, 10)

PVIF 1130 (3%, 10)

First lets find if equation matches at YTM of 6%

= 37.5 * PVIFA (3%, 10)

PVIF 1130 (3.5%, 10)

Now we can use interpolation to get exact answer

Prof Manish Ramuka

1160 .591147 .02

Topic Bond Markets

1000*PVIF (8%, 27)

First lets find if equation matches at YTM of 8%

= 95 * PVIFA (8%, 27)

1000* PVIF (7.5%, 27)

Now we can use interpolation to get exact answer

Prof Manish Ramuka

Topic Bond Markets

3.75PVIFA (3%, 4) + 10000PVIF (3%, 4)

11PVIFA (13%, 3) + 100PVIF (13%, 3)