ch.7 Flashcards
The bonds of ABC, Inc. carry a 10% annual coupon, have a $1,000 face value,
and mature in four years. Bonds of equivalent risk yield 7%. What is the
market value of these bonds?
$1, 101.62
qs 1 tutorial
If a bond with a 7% coupon that pays interest semi-annually with a face value
of $1,000 is priced at par, it will have a market price of and interest
payments in the amount of each.
By definition, ‘priced at par’ means that the market price of the bond is equal
to the face value of $1,000. Sine the coupon is paid semi-annually, each
interest payment will be equal to $1, 000 × 7%
2 =$35.
What is the market value of a bond that will pay a total of 40 semi-annual
coupons of $50 each over the remainder of its life? Assume the bond has a
$1,000 face value and an 8% yield to maturity.
= $1, 197.93
qs 3 tutorial
ABC issued 15-year bonds seven years ago with an annual coupon of 3.5%. The
current yield is now 4.5%. What will be the market value of the bonds today?
$934.04
tutorial qs 4
XYZ issued 10-year bonds three years ago with a semi-annual coupon of 5%.
The current yield is now 4.5%. What will be the market value of the bonds
today?
= $1, 029.74
qs 5 tutorial
Disney Enterprises wants to issue eighty 20-year, $1,000 zero-coupon bonds. If
each bond is to yield 8%, how much will Disney Enterprises receive (ignoring
issuance costs) when the bonds are first sold?
$17, 163.86
Moose Inc. issued an 8-year semi-annual bond three years ago that pays
interest of 3.5% per year. If the face value is $1,000 and the current yield is
4%, what is the market price of the bond?
$977.54
qs 7 tutorial
Is the yield to maturity on a bond the same thing as the required return? Is YTM the same thing as the coupon rate? Suppose today a 10 percent coupon bond sells at par. Two years from now, the required return on the same bond is 8 percent. What is the coupon rate on the bond now? The YTM?
Yes, the YTM is the same thing as required return
No, YTM is not the same thing as coupon rate.
The coupon rate on bond now is 10% and YTM is 10%
The coupon rate is the rate at which periodic coupons are paid
- The YTM is the rate at which the coupon payments and the face value at maturity are discounted to get the current price of the bond.
- So, YTM is the required return while coupon rate is the annual interest rate.
- If the bond was issued at 10% coupon rate:
- The coupon rate will always remains the same as 10%
- So, Coupon rate now is 10%
As the bond sells at par, coupon rate = YTM = 10% today
Langford Co. issued 14-year bonds a year ago at a coupon rate of 6.9%.
The bonds make semiannual payments. If the YTM on these bonds is 5.2%,
what is the current bond price?
1, 159.19 qs 6 homework
Happy Valley Corporation has bonds on the market with 14.5 years to
maturity, a YTM of 6.1%, and a current price of $1,038. The bonds make
semiannual payments. What must the coupon rate be on these bonds?
6.50%.
qs 8 homework
An investment offers a 14% total return over the coming year. Bill
Morneau thinks the total return on this investment will be only 9%. What does
Morneau believe the inflation rate will be over the next year?
4.59%.
homework qs 11
Say you own an asset that had a total return last year of 10.7%. If the
inflation rate last year was 3.7%, what was your real return?
6.75%.
homework qs 12
At the time of the last referendum, Quebec provincial bonds carried a
higher yield than comparable Ontario bonds because of investors’ uncertainty
about the political future of Quebec. Suppose you were an investment manager
who thought the market was overpaying these fears. In particular, suppose you
thought that yields on Quebec bonds would fall by 50 basis points. Which
bonds would you buy or sell? Explain your choices.
There is a negative relationship
between bond yields and bond prices. If an investment manager thinks that
yields on Quebec provincial bonds will decrease then (s)he should buy them
because they will increase in price and any investor who buys the bonds at
today’s price will receive a capital gain. In order to fund this purchase of
Quebec bonds, he should short (sell) the Ontario bonds with the same maturity.
Suppose your company needs to raise $45 million and you want to issue
30-year bonds for this purpose. Assume the required return on your bond issue
will be 6%, and you’re evaluating two issue alternatives: a 6% annual coupon
bond and a zero-coupon bond. Your company’s tax rate is 35%.
How many of the coupon bonds would you need to issue to raise the $45
million? How many of the zeroes would you need to issue?
For the coupon bond, the annual coupon rate and the yield are equal to
each other, both being 6%. This implies that the market price of the coupon
bond is equal to the face value. In other words, the coupon bonds trade at par.
Therefore, since each bond has a face value of $1,000 , the company needs to
sell $45, 000, 000 ÷ $1, 000 = 45, 000 number of coupon bonds.
On the other hand, the market price of zero-coupon bond is
PV = F/(1 + r )t = $1, 000/(1 + 0.06)30 = $174.11. Therefore, to fund $45
million, the company needs to sell $45, 000, 000 ÷ $174.11 = 258, 457.30
number of zero-coupon bonds.
Suppose your company needs to raise $45 million and you want to issue
30-year bonds for this purpose. Assume the required return on your bond issue
will be 6%, and you’re evaluating two issue alternatives: a 6% annual coupon
bond and a zero-coupon bond. Your company’s tax rate is 35%.
b. In 30 years, what will your company’s repayment be if you issue the coupon
bonds? What if you issue the zeroes?
For coupon bond, you pay the regular (last) coupon amount ant the
principal at the maturity date. That is, you will pay the regular coupon of
$1, 000 × 6% = $60 and the principal amount of $1,000, hence the total of
$1,060 for each bond. So, the total payment will be
$1, 060 × 45, 000 = $47, 700, 000.
For zero-coupon bond, you only return the principal amount of $1,000 at the
maturity. Hence, the total payment will be
$1, 000 × 258, 457.30 = $258, 457, 300.
