chap005solutions

chap005solutions - Solutions to Chapter 5 Valuing Bonds 1....

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Solutions to Chapter 5 Valuing Bonds 1. a.Coupon rate = 6%, which remains unchanged. The coupon payments are fixed at $60 per year. b. When the market yield increases, the bond price will fall. The cash flows are discounted at a higher rate. c.At a lower price, the bond’s yield to maturity will be higher. The higher yield to maturity for the bond is commensurate with the higher yields available in the rest of the bond market. d. Current yield = coupon rate/bond price As coupon rate remains the same and the bond price decreases, the current yield increases. 2. When the bond is selling at a discount, $970 in this case, the yield to maturity is greater than 8%. We know that if the yield to maturity were 8%, the bond would sell at par. At a price below par, the yield to maturity exceeds the coupon rate. Current yield = coupon payment/bond price = $80/$970 Therefore, current yield is also greater than 8%. 3. Coupon payment = 0.08 × $1,000 = $80 Current yield = $80/bond price = 0.07 Therefore: bond price = $80/0.07 = $1,142.86 4. Coupon rate = $80/$1,000 = 0.080 = 8.0% Current yield = $80/$950 = 0.0842 = 8.42% To compute the yield to maturity, use trial and error to solve for r in the following equation: 6 6 ) r 1 ( 000 , 1 $ r) (1 r 1 r 1 $80 $950 + + + × - × = r = 9.119% Using a financial calculator, compute the yield to maturity by entering: n = 6; PV = ( - )950; FV = 1000; PMT = 80, compute i = 9.119% 5-1
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Verify the solution as follows: 98 . 949 $ 09119 . 1 000 , 1 $ ) 09119 . 1 ( 09119 . 0 1
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chap005solutions - Solutions to Chapter 5 Valuing Bonds 1....

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