BOND VALUATION

QUESTION 1
a) Calculate the yield to maturity for the two year zero coupon. (use mathematical formula)
YTMn = (FVn/P)1/n 1
YTM2 = ($100/$89.68)1/2 1
= 1.05597 1
= 0.0559 @ 5.597%

b) Calculate the yield to maturity for the three year zero-coupon bond. (use financial
calculator)
FV
PV
N
Thus, I/YR

$100
-$85.40
3
5.4016%

QUESTION 2
a) Calculate the price today of a two-year default-free security with a face value of $1000 and
an annual coupon rate of 5%.

CPN = 5% $1000 = $50

FV = $1000

P=

CPN
CPN
CPN + FV
+
+ +
2
n
1+YTM 1 ( 1+YTM 2 )
( 1+YTM n )

P=

$ 50
$ 50+1000
+
1+0.0325 ( 1+0.0352 )2

P=$ 48.4262+ $ 980.1862

P=$ 1028.6124

b) Calculate the price today of a three-year default-free security with a face value of $1000
and annual coupon rate of 4%. (use financial calculator)
FV
PMT
N
I/YR
Thus, PV

$1000
$40 (Derived from 4% $1000)
3
3.90
-$1002.7804

RATIO ANALYSIS
QUESTION 5
Aristocrats Art reported the following trend analysis to its bank as an attachment to a loan
application.
Fixed Charge Ratio
Times Interest Earned Ratio
Debt Ratio
Debt to Tangible Net Worth Ratio
Debt to Equity Ratio

2010
4.00
4.94
0.47
0.91
0.89

2009
2.50
3.17
0.51
1.06
1.04

2008
1.54
2.08
0.56
1.36
1.27

The industry average of the debt to equity ratio is 1 to 1.

Comment on the long-term borrowing ability of this company based on the ratios given
above.

ANSWER:

Higher fixed charge ratio is favorable as it indicates a firms ability to satisfy

financing expenses such as interest and leases.
Higher times interest earned ratio is favorable; meaning greater ability of a business to
repay its interest and debt.
Lower debt ratio is favorable as it shows that less companys assets are financed
through debts.
Lower debt to tangible net worth ratio indicates greater long-term financial safety and
greater flexibility to borrow in the future.
Lower debt to equity ratio is favorable as it shows that the company is being financed
by its own financial resources rather than creditors.
Overall, Aristocrats Art shows evidence of an improved, long term borrowing ability.
Fixed charge ratio and times interest earned ratio has increased from 2008 until 2010.
In addition, debt ratio, debt to tangible net worth ratio and debt to equity ratio also
improved. It is worth to note that debt to equity ratio is below the industry average
implying that there has been very successful management of debt levels.