Chapter 6 (2)

# Chapter 6 (2) - 1. The Timberlake-Jackson Wardrobe Co. has...

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The Timberlake-Jackson Wardrobe Co. has 10.2 percent coupon bonds on the market with eleven years left to maturity. The bonds make annual payments. Required: If the bond currently sells for \$1,165.00, what is its YTM? (Do not include the percent sign (%). Round your answer to 2 decimal places (e.g., 32.16).) Yield to maturity % Explanation: Here, we need to find the YTM of a bond. The equation for the bond price is: P = \$1,165.00 = \$102(PVIFA R% ,11 ) + \$1,000(PVIF R %,11 ) Notice the equation cannot be solved directly for R . Using a spreadsheet, a financial calculator, or trial and error, we find: R = YTM = 7.90% If you are using trial and error to find the YTM of the bond, you might be wondering how to pick an interest rate to start the process. First, we know the YTM has to be lower than the coupon rate since the bond is a premium bond. That still leaves a lot of interest rates to check. One way to get a starting point is to use the following equation, which will give you an approximation of the YTM: Approximate YTM = [Annual interest payment + (Par value – Price) / Years to maturity] / [(Price + Par value) / 2] Solving for this problem, we get: Approximate YTM = [\$102 + (–\$165.00 / 11)] / [(\$1,165.00 + 1,000) / 2] Approximate YTM = .0804 or 8.04% Calculator Solution:
Enter 11 ±\$1,165.00 \$102 \$1,000 N I/Y PV PMT FV

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Solve for 7.90% 2. App Store Co. issued 15-year bonds one year ago at a coupon rate of 7.1 percent. The bonds make semiannual payments. Required: If the YTM on these bonds is 5.4 percent, what is the current bond price? (Do not include the dollar sign (\$). Round your answer to 2 decimal places (e.g., 32.16).) Current bond price \$ Explanation: To find the price of this bond, we need to realize that the maturity of the bond is 14 years. The bond was issued one year ago, with 15 years to maturity, so there are 14 years left on the bond. Also, the coupons are semiannual, so we need to use the semiannual interest rate and the number of semiannual periods. The price of the bond is: P = \$35.50(PVIFA 2.70%,28 ) + \$1,000(PVIF 2.70%,28 ) P = \$1,165.51 Calculator Solution: Enter 14 × 2 5.4% / 2 ±\$71 / 2 ±\$1,000 N
I/Y PV PMT FV Solve for \$1,165.51 3. If Treasury bills are currently paying 5.80 percent and the inflation rate is 2.7 percent, what is the approximate and the exact real rate of interest? (Do not include the percent signs (%). Round your answers to 2 decimal places (e.g., 32.16).) Approximate % Exact % Explanation: The approximate relationship between nominal interest rates ( R ), real interest rates ( r ), and inflation ( h ), is: R = r + h Approximate r = 0.0580 –0.027 Approximate r =0.0310 or 3.10% The Fisher equation, which shows the exact relationship between nominal interest rates, real interest rates, and inflation, is: (1 + R ) = (1 + r )(1 + h ) (1 + 0.0580) = (1 + r )(1 + 0.027) Exact r = [(1 + 0.0580) / (1 + 0.027)] – 1 Exact r = 0.0302 or 3.02%

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4. Bond X is a premium bond making annual payments. The bond pays an 8.4 percent coupon, has a YTM of 6.4
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## This note was uploaded on 02/24/2011 for the course ACCT 416 taught by Professor Staff during the Winter '08 term at USC.

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Chapter 6 (2) - 1. The Timberlake-Jackson Wardrobe Co. has...

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