CHAPTER
3 3-1
VALUING BONDS
PROBLEM SOLVING
Brealey, Myers, and Allen
Principles of Corporate Finance
13th Edition
Slides by Matthew Will
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Problem 1
3-2
A 10-year bond is issued with a face value of $1,000,
paying interest of $60 a year. If interest rates increase
shortly after the bond is issued, what happens to the
bond’s
[Link] rate?
Does not change. The coupon rate is set at time of
issuance.
[Link]?
Price falls. The yield to maturity and the price are
inversely related.
3. Yield to maturity?
Yield to maturity rises. Since the price falls, the bond’s
yield to maturity will rise.
Problem 2
3-3
A 10-year German government bond (bund) has a face
value of €100 and a coupon rate of 5% paid annually.
Assume that the interest rate (in euros) is equal to 6%
per year. What is the bond’s PV?
PV = (.05 × €100) × ((1 / .06) – {1 / [.06 × (1 + .06)10]})
+ €100 / (1 + .06)10
PV = €92.64
OR
N=10; FV=100; PMT=5; i=6; CPT PV=?
Problem 3
3-4
Essary Enterprises has bonds on the market making annual payments,
with eight years to maturity, a par value of $1,000, and selling for $948.
At this price, the bonds yield 5.9 percent. What must the coupon rate be
on the bonds?
Here we need to find the coupon payment of the bond first. All we need to do is to solve for
the coupon payment as follows:
Enter 8 5.9% ±$948 $1,000
N I/Y PV PMT FV
Solve for $50.66
Coupon rate = $50.66 / $1,000 = 5.07%
Solving for the coupon payment, we get:
C = $50.66
The coupon payment is the coupon rate times par value. Using this relationship, we get:
Coupon rate = $50.66 / $1,000 = 0.0507, or 5.07%
3-4
Problem 4
3-5
A 10-year U.S. Treasury bond with a face value of
$1,000 pays a coupon of 5.5% on semi-annual basis.
The reported yield to maturity is 5.2%. What is the
present value of the bond?
PV = (.0275 × $1,000) × ((1 / .026) – {1 / [.026(1 +
.026)10×2 ]}) + $1,000 / (1 + .026)10×2
PV = $1,023.16
OR
N=20; FV=1000; PMT=27.5; i=2.6; CPT PV=?
Problem 5
3-6
Sqeekers Co. issued 15-year bonds a year ago at a coupon
rate of 4.1 percent. The bonds make semiannual payments
and have a par value of $1,000. If the YTM on these bonds is
4.5 percent, what is the current bond price?
To find the price of this bond, we need to realize that the maturity of the bond
is 14 years. The bond was issued 1 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:
Enter 28 4.5% / 2 $41 / 2 $1,000
N I/Y PV PMT FV
Solve for $958.78
3-6
Problem 6
3-7
Heginbotham Corp. issued 20-year bonds two years ago at a coupon
rate of 5.3 percent. The bonds make semiannual payments. If these
bonds currently sell for 105 percent of par value, what is the YTM?
The bond was issued 2 years ago, so n = 18*2 = 36
Coupon Payment = 5.3% * 1,000 = 53/2 = 26.5
Enter 36 ±$1,050 $53 / 2 $1,000
N I/Y PV PMT FV
Solve for 2.440%
2.440% 2 = 4.88%
3-7
Problem 7
3-8
Duration: True or false? Explain.
[Link]-maturity bonds necessarily have longer
durations.
False. Duration depends on the coupon as well as the
maturity
2. The longer a bond’s duration, the lower its volatility.
False. Given the yield to maturity, volatility is proportional
to duration
3. Other things equal, the lower the bond coupon, the
higher its volatility.
True. A lower coupon rate means longer duration and
therefore higher volatility
4. If interest rates rise, bond durations rise also.
False. A higher interest rate reduces the relative present
value of distant principal repayments
Problem 8
3-9
Duration: Calculate the durations and volatilities of securities
A, B, and C. Their cash flows are shown below. The interest
rate is 8%. Period 1 Period 2 Period 3
A 40 40 40
B 20 20 120
C 10 10 110
Volatility
Proportion =
of Total Proportion (Duration
Year Ct PV(Ct) Value × Time / (1 + r)
r = 8%
Security A 1 40 37.04 .3593 .3593
2 40 34.29 .3327 .6654
3 40 31.75 .3080 .9241
Total PV = 103.08 1.0000 Duration = 1.9487 1.80
Security B 1 20 18.52 .1414 .1414
2 20 17.15 .1310 .2619
3 120 95.26 .7276 2.1828
Total PV = 130.93 1.0000 Duration = 2.5861 2.39
Security C 1 10 9.26 .0881 .0881
2 10 8.57 .0815 .1631
3 110 87.32 .8304 2.4912
Total PV = 105.15 1.00 Duration = 2.7424 2.54
Problem 9
3-10
Real interest rates: The two-year interest rate is 10%
and the expected annual inflation rate is 5%.
[Link] is the expected real interest rate?
r = 1.10 / 1 .05 – 1
r = .0476, or 4.76%
2. If the expected rate of inflation suddenly rises to 7%,
what does Fisher’s theory say about how the nominal
interest rate will change?
rNominal = 1.0476 × 1.07 – 1
rNominal = .1210, or 12.10%
