CHAPTER 14: BOND PRICES AND YIELDS
1.
a.
Effective annual rate for 3month Tbill:
%
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.
2.
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%.
3.
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.
4.
The bond price will be lower.
As time passes, the bond price, which is now above
par value, will approach par.
5.
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%
141
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View Full Document6.
a.
A sinking fund provision requires the early redemption of a bond issue.
The
provision may be for a specific number of bonds or a percentage of the bond
issue over a specified time period.
The sinking fund can retire all or a portion
of an issue over the life of the issue.
b.
(i) Compared to a bond without a sinking fund, the sinking fund reduces the
average life of the overall issue because some of the bonds are retired prior to
the stated maturity.
(ii) The company will make the same total principal payments over the life of
the issue, although the timing of these payments will be affected.
The total
interest payments associated with the issue will be reduced given the early
redemption of principal.
c.From the investor’s point of view, the key reason for demanding a sinking fund is
to reduce credit risk.
Default risk is reduced by the orderly retirement of the
issue.
7.
a.
(i) Current yield = Coupon/Price = $70/$960 = 0.0729 = 7.29%
(ii) YTM = 3.993% semiannually or 7.986% annual bond equivalent yield.
On a financial calculator, enter: n = 10; PV = –960; FV = 1000; PMT = 35
Compute the interest rate.
(iii) Realized compound yield is 4.166% (semiannually), or 8.332% annual
bond equivalent yield.
To obtain this value, first find the future value (FV) of
reinvested coupons and principal.
There will be six payments of $35 each,
reinvested semiannually at 3% per period.
On a financial calculator, enter:
PV = 0; PMT = 35; n = 6; i = 3%.
Compute: FV = 226.39
Three years from now, the bond will be selling at the par value of $1,000
because the yield to maturity is forecast to equal the coupon rate.
Therefore,
total proceeds in three years will be: $226.39 + $1,000 =$1,226.39
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 Three '11
 Sanghoonlee
 Interest Rates, Interest, Interest Rate, Colina bond

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