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Chapter 5.

Solution to Ch05 P24 Build a Model

A 20-year, 8% semiannual coupon bond with a par value of $1,000 may be called in 5 years at a call price of $1,040. The
bond sells for $1,100. (Assume that the bond has just been issued.)
Basic Input Data:
Years to maturity:
Periods per year:
Periods to maturity:
Coupon rate:
Par value:
Periodic payment:
Current price
Call price:
Years till callable:
Periods till callable:

20
2
40
8%
$1,000
$40
$1,100
$1,040
5
10

a. What is the bond's yield to maturity?


Peridodic YTM =
Annualized Nominal YTM =

3.53%
7.06% Hint: This is a nominal rate, not the effective rate. Nominal rates are generally qu

b. What is the bond's current yield?


Current yield = Ann. Coupon
Current yield =
$80
Current yield =
7.27%

Price
$1,100

Hint: Write formula in words.


Hint: Cell formulas should refer to Input Section
(Answer)

c. What is the bond's capital gain or loss yield?


Cap. Gain/loss yield =
Cap. Gain/loss yield =
Cap. Gain/loss yield =

YTM
7.06%
-0.21%

Current yield Hint: Write formula in words.


7.27%
Hint: Cell formulas should refer to Input Section
(Answer)

Note that this is an economic loss, not a loss for tax purposes.
d. What is the bond's yield to call?
Here we can again use the Rate function, but with data related to the call.
Peridodic YTC =
Annualized Nominal YTC =

3.16%
6.33% This is a nominal rate, not the effective rate. Nominal rates are generally quoted.

The YTC is lower than the YTM because if the bond is called, the buyer will lose the difference between the call price and the
current price in just 4 years, and that loss will offset much of the interest imcome. Note too that the bond is likely to be called
and replaced, hence that the YTC will probably be earned.
NOW ANSWER THE FOLLOWING NEW QUESTIONS:
e. How would the price of the bond be affected by changing the going market interest rate? (Hint: Conduct a sensitivity
analysis of price to changes in the going market interest rate for the bond. Assume that the bond will be called if and only
if the going rate of interest falls below the coupon rate. That is an oversimplification, but assume it anyway for purposes
of this problem.)
Nominal market rate, r:
Value of bond if it's not called:
Value of bond if it's called:

8%
$1,000.00
$1,027.02

The bond would not be called unless r<coupon.

We can use the two valuation formulas to find values under different r's, in a 2-output data table, and then use an IF
statement to determine which value is appropriate:

Rate, r
0%
2%
4%
6%
8%
10%
12%
14%
16%

Value of Bond If:


Not called
Called
$1,000.00
$1,027.02

Actual value,
considering
call likehood:
$1,440.00

f. Now assume the date is 10/25/2010. Assume further that a 12%, 10-year bond was issued on 7/1/2010, pays interest
semiannually (January 1 and July 1), and sells for $1,100. Use your spreadsheet to find the bonds yield.
Refer to this chapter's Tool Kit for information about how to use Excel's bond valuation functions. The model finds the price of a
bond, but the procedures for finding the yield are similar. Begin by setting up the input data as shown below:

Settlement (today)
Maturity
Coupon rate
Current price (% of par)
Redemption (% of par value)
Frequency (for semiannual)
Basis (360 or 365 day year)

Yield to Maturity:

Basic info:
10/25/2010
7/1/2020
12%
110
100
2
1

7/1/2020

104

10.34% Hint: Use the Yield function.For dates, either refer to cells D122 and D123, or enter the date in quo

To find the yield to call, use the YIELD function, but with the call price rather than par value as the redemption
Yield to call:

10.57%

You could also use Excel's "Price" function to find the value of a bond between interest payment dates.

at a call price of $1,040. The

ective rate. Nominal rates are generally quoted.

d refer to Input Section

d refer to Input Section

ate. Nominal rates are generally quoted.

etween the call price and the


he bond is likely to be called

(Hint: Conduct a sensitivity


ond will be called if and only
ume it anyway for purposes

nd then use an IF

on 7/1/2010, pays interest


bonds yield.

The model finds the price of a


own below:

s D122 and D123, or enter the date in quotes, such as "10/25/2010".