# Chap014 - Chapter 14 Bond Prices and Yields CHAPTER 14 BOND...

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Chapter 14 - Bond Prices and Yields CHAPTER 14: BOND PRICES AND YIELDS PROBLEM SETS 1. The bond callable at 105 should sell at a lower price because the call provision is more valuable to the firm. Therefore, its yield to maturity should be higher. 2. Zero coupon bonds provide no coupons to be reinvested. Therefore, the investor's proceeds from the bond are independent of the rate at which coupons could be reinvested (if they were paid). There is no reinvestment rate uncertainty with zeros. 3. A bond’s coupon interest payments and principal repayment are not affected by changes in market rates. Consequently, if market rates increase, bond investors in the secondary markets are not willing to pay as much for a claim on a given bond’s fixed interest and principal payments as they would if market rates were lower. This relationship is apparent from the inverse relationship between interest rates and present value. An increase in the discount rate (i.e., the market rate) decreases the present value of the future cash flows. 4. a.Effective annual rate for 3-month T-bill: % 0 . 10 100 . 0 1 02412 . 1 1 645 , 97 000 , 100 4 4 = = - = - b. Effective annual interest rate for coupon bond paying 5% semiannually: (1.05) 2 – 1 = 0.1025 or 10.25% Therefore the coupon bond has the higher effective annual interest rate. 5. The effective annual yield on the semiannual coupon bonds is 8.16%. If the annual coupon bonds are to sell at par they must offer the same yield, which requires an annual coupon rate of 8.16%. 6. The bond price will be lower. As time passes, the bond price, which is now above par value, will approach par. 14-1

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Chapter 14 - Bond Prices and Yields 7. Yield to maturity : Using a financial calculator, enter the following: n = 3; PV = - 953.10; FV = 1000; PMT = 80; COMP i This results in: YTM = 9.88% Realized compound yield : First, find the future value (FV) of reinvested coupons and principal: FV = (\$80 × 1.10 × 1.12) + (\$80 × 1.12) + \$1,080 = \$1,268.16 Then find the rate (y realized ) that makes the FV of the purchase price equal to \$1,268.16: \$953.10 × (1 + y realized ) 3 = \$1,268.16 y realized = 9.99% or approximately 10% 8. a. Zero coupon 8% coupon 10% coupon Current prices \$463.19 \$1,000.00 \$1,134.20 b. Price 1 year from now \$500.25 \$1,000.00 \$1,124.94 Price increase \$37.06 \$0.00 \$9.26 Coupon income \$0.00 \$80.00 \$100.00 Pre-tax income \$37.06 \$80.00 \$90.74 Pre-tax rate of return 8.00% 8.00% 8.00% Taxes* \$11.12 \$24.00 \$28.15 After-tax income \$25.94 \$56.00 \$62.59 After-tax rate of return 5.60% 5.60% 5.52% c.Price 1 year from now \$543.93 \$1,065.15 \$1,195.46 Price increase \$80.74 \$65.15 \$61.26 Coupon income \$0.00 \$80.00 \$100.00 Pre-tax income \$80.74 \$145.15 \$161.26 Pre-tax rate of return 17.43% 14.52% 14.22% Taxes** \$19.86 \$37.03 \$42.25 After-tax income \$60.88 \$108.12 \$119.01 After-tax rate of return 13.14% 10.81% 10.49% 14-2
Chapter 14 - Bond Prices and Yields

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## This note was uploaded on 04/03/2010 for the course FEAS 311.01 taught by Professor Attilaodabaşı during the Spring '10 term at Boğaziçi University.

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Chap014 - Chapter 14 Bond Prices and Yields CHAPTER 14 BOND...

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