Practice_Problems_6_Bond_Valuation

# Practice_Problems_6_Bond_Valuation - FIN340 PRACTICE...

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1 FIN340 PRACTICE PROBLEM SET 6 BOND VALUATION 1. Suppose that currently 5-year government bonds are selling at a yield of four percent. Please determine the value a 5-year government bond with a 6 percent coupon rate and a face value of 1,000. a. Start by assuming that the bond is issued by a continental European government and makes annual coupon payments. [Solution] With annual coupon payments of 0.06*1,000 = 60, the value of the bond can be determined by the annuity formula plus discounting the repayment of principal after 5 years: 1,089.04 (1.04) 1,000 (1.04) 0.04 1 0.04 1 60 PV 5 5 = + × × = b. Then rework your answer assuming that he bond is issued by the U.S. Treasury, so that the bond pays semiannual coupons and the semiannual yield for semiannually compounded US bonds is 2 percent. [Solution] With semi-annual coupon payments of 0.03*1,000 = 30: 1,089.83 (1.02) 1,000 (1.02) 0.02 1 0.02 1 30 PV 10 10 = + × × = c. How would your answers to a. and b. change if the annual (semiannual) yield drops to 3% (1.5%)? [Solution] With annual coupon payments: 1,137.39 (1.03) 1,000 (1.03) 0.03 1 0.03 1 60 PV 5 5 = + × × = With semi-annual coupon payments: 1,138.33 (1.015) 1,000 (1.015) 0.015 1 0.015 1 30 PV 10 10 = + × × = 2. A 6-year government bond makes annual coupon payments of 5 percent on a par value of 1,000 and trades at a yield of 3 percent annually compounded.

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2 a. Suppose that one year later the bond still yields three percent. What return has the bondholder earned over this 12-month period?
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## This note was uploaded on 09/21/2009 for the course B 340 taught by Professor Narg during the Spring '09 term at Washington University in St. Louis.

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Practice_Problems_6_Bond_Valuation - FIN340 PRACTICE...

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