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Principles of Corporate Finance(11th edition)_Chap003

Chapter 03 - Valuing Bonds

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CHAPTER
3
Valuing
Bonds

Principles of Corporate Finance(11th edition)_

Answers to Problem Sets
Chap003
(1)

818

11,,3

1.

22

a.

Does not change. The coupon rate is set at time of issuance.

b.

Price falls. Market yields and prices are inversely related.

c.

Yield rises. Market yields and prices are inversely related.

Est. Time: 01-05

2.

a.

If the coupon rate is higher than the yield, then investors must be
expecting a decline in the capital value of the bond over its remaining life.
Thus, the bonds price must be greater than its face value.

b.

Conversely,
if the
yield
is over
greater
the coupon,
face value and
it will
rise
thethan
remaining
life of the
the price
bond.will be below

Est. Time: 01-05

3.

The yield over six months is 2.7/2 = 1.35%.

The six-month coupon payment is $6.25/2 = $3.125.
There are 18 years between today (2012) and 2030; since coupon payments are
listed every six months, there will be 36 payment periods.
Therefore, PV = $3.125 / 1.0135 + $3.125 / (1.0135) 2 + . . . $103.125 / (1.0135) 36
= $150.35.

Est. Time: 01-05

4.

Yields to maturity are about 4.3% for the 2% coupon, 4.2% for the 4% coupon,
and 3.9% for the 8% coupon. The 8% bond had the shortest duration (7.65
years), the 2% bond the longest (9.07 years).The 4% bond had a duration of 8.42
years.
Est. Time: 01-05

5.

a.
Fall. Example: Assume a one-year, 10% bond. If the interest rate is 10%,
the bond is worth $110/1.1 = $100. If the interest rate rises to 15%, the bond is
worth $110/1.15 = $95.65.
3-1

2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 03 - Valuing Bonds

b.
Less (e.g., see 5aif the bond yield is 15% but the coupon rate is lower at
10%, the price of the bond is less than $100).
c.

Less (e.g., with r = 5%, one-year 10% bond is worth $110/1.05 = $104.76).

d.
Higher (e.g., if r = 10%, one-year 10% bond is worth $110/1.1 = $100,
while one-year 8% bond is worth $108/1.1 = $98.18).
e.

No. Low-coupon bonds have longer durations (unless there is only one
period to maturity) and are therefore more volatile (e.g., if r falls from 10%
to 5%, the value of a two-year 10% bond rises from $100 to $109.3 (a rise
of 9.3%). The value of a two-year 5% bond rises from $91.3 to $100 (a
rise of 9.5%).

Est. Time: 01-05

6.

a.

Spot interest rates. Yield to maturity is a complicated average of the

separate spot rates of interest.

b.

Bond
prices.
bond price
is determined
bybond
the bonds
cashthe
flows
and
the spot
rates The
of interest.
Once
you know the
price and
bonds
cash flows, it is possible to calculate the yield to maturity.
Est. Time: 01-05

7.

a.
b.

4%; each bond will have the same yield to maturity.

PV = $80/(1.04) + $1,080/(1.04) 2 = $1,075.44.

Est. Time: 01-05

8.

a.

5
105
PV $ 1 # r # !1 # r "2
1
2

b.

5 # 105
$
PV
1 # y !1 # y "2

c.
Less (it is between the one-year and two-year spot rates).
Est. Time: 01-05
9.

a.

The two-year spot rate is r2 = (100/99.523).5 1 = 0.24%.

The three-year spot rate is r3 = (100/98.937).33 1 = 0.36%.
The four-year spot rate is r4 = (100/97.904).2.25 1 = 0.53%.
The five-year spot rate is r5 = (100/96.034) 1 = 0.81%.
3-2

2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 03 - Valuing Bonds

b.

Upward-sloping.

c.

Higher (the yield on the bond is a complicated average of the separate

spot rates).
Est. Time: 01-05

10.

a.
b.
c.

Price today is $108.425; price after one year is $106.930.

Return = (8 + 106.930)/108.425 - 1 = .06, or 6%.
If a bonds yield to maturity is unchanged, the return to the bondholder is
equal to the yield.

Est. Time: 01-05

11.

a.

False. Duration depends on the coupon as well as the maturity.

b.

False. Given the yield to maturity, volatility is proportional to duration.

c.

True. A lower coupon rate means longer duration and therefore higher
volatility.

d.

False. A higher interest rate reduces the relative present value of (distant)
principal repayments.

Est. Time: 01-05

3-3
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 03 - Valuing Bonds

12.
Proportion
of Total

Proportion

Year

Security A

C tt

PV(C tt)

1
2
3

40
40
40
V

Security B

1
2
3

Security C

37.04
34.29
31.75
103.08

0.3593
0.3327
0.3080
1.00

18.52
17.15
95.26

0.1414
0.1310
0.7276

130.93

1.00

9.26
8.57
87.32
105.15

0.0881
0.0815
0.8304
1.00

=
20
20
120

V
1
2
3

10
10
110
V

Value

Time

Duration =

Volatility

0.3593
0.6654
0.9241
1.9487

1.80

0.1414
0.2619
2.1828
Duration =

2.5861

2.39

Duration =

0.0881
0.1631
2.4912
2.7424

2.54

Est. Time: 06-10

13.

7.01%; the extra return that you earn for investing for two years rather than one
2

year is 1.06 /1.05 1 = .0701.

Est. Time: 01-05
14.

a.

Real rate = 1.10/1.05 1 = .0476, or 4.76%.

b.

The real rate does not change. The nominal rate increases to 1.0476
1.07 1 = .1209, or 12.09%.

Est. Time: 01-05

15.

With annual coupon payments:

( 1
%
1
100 !
!
)
*
"
PV 5 &
92.64
10 #
10
)
0.06
0.06
(1.06)
(1.06)
'
$

Est. Time: 01-05

3-4
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 03 - Valuing Bonds

16.

a.

(
% " 10,000 !
1
PV ! 275 ) & 1 *
$10,231.64
20 #
20
)
' 0.026 0.026 (1.026) $ (1.026)

b.
Interest
Rate

PV of
Interest

PV of
Face Value

PV of Bond

1.0%

$5,221.54

$9,050.63

$14,272.17

2.0%
3.0%
4.0%
5.0%
6.0%

4,962.53
4,721.38
4,496.64
4,287.02
4,091.31

8,195.44
7,424.70
6,729.71
6,102.71
5,536.76

13,157.97
12,146.08
11,226.36
10,389.73
9,628.06

7.0%
8.0%
9.0%
10.0%
11.0%

3,908.41
3,737.34
3,577.18
3,427.11
3,286.36

5,025.66
4,563.87
4,146.43
3,768.89
3,427.29

8,934.07
8,301.21
7,723.61
7,196.00
6,713.64

12.0%
13.0%
14.0%
15.0%

3,154.23
3,030.09
2,913.35
2,803.49

3,118.05
2,837.97
2,584.19
2,354.13

6,272.28
5,868.06
5,497.54
5,157.62

Est. Time: 06-10

17.

Purchase price for a six-year government bond with 5% annual coupon:

( 1
% 1,000
1
!
)
*
"
! $1,108.34
PV 50 &
6 #
6
' 0.03 0.03 ) (1.03) $ (1.03)
The price one year later is equal to the present value of the remaining five years
of the bond:

( 1
% 1,000
1
*
"
! $1,091.59
PV ! 50 ) &
5#
5
)
' 0.03 0.03 (1.03) $ (1.03)
Rate of return = [$50 + ($1,091.59 $1,108.34)]/$1,108.34 = 3.00%
Price one year later (yield = 2%):

( 1
% 1,000
1
!
)
*
"
! $1,141.40
PV 50 &
5 #
5
' 0.02 0.02 ) (1.02) $ (1.02)
3-5
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

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