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FV Question

Q3 page 32

(a) The portfolio manager of a tax-exempt fund is considering investing $500,000 in a debt
instrument that pays an annual interest rate of 5.7% for four years. At the end of four
years, the portfolio manager plans to reinvest the proceeds for three more years and
expects that for the three-year period, an annual interest rate of 7.2% can be earned. What
is the future value of this investment?
(b) Suppose that the portfolio manager in Question 3, part a, has the opportunity to invest
the $500,000 for seven years in a debt obligation that promises to pay an annual interest
rate of 6.1% compounded semiannually. Is this investment alternative more attractive than
the one in Question 3, part a?

(a) The portfolio manager of a tax-exempt fund is considering investing $500,000 in a debt
instrument that pays an annual interest rate of 5.7% for four years. At the end of four
years, the portfolio manager plans to reinvest the proceeds for three more years and
expects that for the three-year period, an annual interest rate of 7.2% can be earned. What
is the future value of this investment?
At the end of year four, the portfolio managers amount is given by: Pn = P0 (1 + r)n. Inserting in
our values, we have P4 = $500,000(1.057)4 = $500,000(1.248245382) = $624,122.66. In three
more years at the end of year seven, the manager amount is given by: P7 = P4(1 + r)3. Inserting in
our values, we have: P7 = $624,122.66(1.072)3 = $624,122.66(1.231925248) = $768,872.47.
(b) Suppose that the portfolio manager in Question 3, part a, has the opportunity to invest
the $500,000 for seven years in a debt obligation that promises to pay an annual interest
rate of 6.1% compounded semiannually. Is this investment alternative more attractive than
the one in Question 3, part a?
At the end of year seven, the portfolio managers amount is given by the following equation,
which adjusts for semiannual compounding. We have: Pn = P0(1 + r/2)2(n). Inserting in our values,
we have P7 = $500,000(1 + 0.061/2)2(7) = $500,000(1.0305)14 = $500,000(1.522901960) =
$761,450.98. Thus, this investment alternative is not more attractive. It is less by the amount of
$761,450.98 $768,872.47 = $7,421.49.

Q8 Page 33
8. Calculate for each of the following bonds the price per $1,000 of par
value assuming semiannual coupon payments.

Bond

Coupon Rate (%)

Years to Maturity

Required Yield (%)

20

15

10

14

Consider a 9-year 8% coupon bond with a par value of $1,000 and a required yield
of 7%. Given C = 0.08($1,000) / 2 = $40, n = 2(9) = 18 and r = 0.07 / 2 = 0.035,
the present value of the coupon payments is:

1
1

1 r n
P = C

18

1.035
$40

0.035

1 0.538361140

$40

0.035

1 1.857489196
$40

0.035

$40 13.189681727
=

= $527.587.

1+ r
The present value of the par or maturity value of $1,000 is:

$1, 000
1.8574892

$1,000
(1.035)18

$538.361. Thus, the price of the bond (P) = present value of coupon payments +
present value of par value = $527.587 + $538.361 = $1,065.95.

Consider a 20-year 9% coupon bond with a par value of $1,000 and a required yield
of 9%. Given C = 0.09($1,000) / 2 = $45, n = 2(20) = 40 and r = 0.09 / 2 = 0.045,
the present value of the coupon payments is:

1
1 1 r n
P = C

1 1.045 40
$45

0.045

= $45[18.401584] = $828.071.

1 5.81863645
$45

0.045

1 0.1719287
0.045

$45
=

$1, 000
1.045 40

1+ r

The present value of the par or maturity value of $1,000 is:

$1, 000
5.81863645

$171.929. Thus, the price of the bond (P) = $828.071 + $171.929 = $1,000.00.
[NOTE. We already knew the answer would be $1,000 because the coupon rate
equals the yield to maturity.]

Consider a 15-year 6% coupon bond with a par value of $1,000 and a required yield
of 10%. Given C = 0.06($1,000) / 2 = $30, n = 2(15) = 30 and r = 0.10 / 2 = 0.05,
the present value of the coupon payments is:

1
1 1 r n
P=C

1
1 1.05 30
$30

0.05

1 4.3219424
$30

0.05

1 0.2313774

0.05

$30
=

= $30[15.372451] = $461.174.

$1, 000
1.05 30

1+ r
The present value of the par or maturity value of $1,000 is:

$1,000
4.3219424

$231.377. Thus, the price of the bond (P) = $461.174 + $231.377 = $692.55.

Consider a 14-year 0% coupon bond with a par value of $1,000 and a required yield
of 8%. Given C = 0($1,000) / 2 = $0, n = 2(14) = 28 and r = 0.08 / 2 = 0.04, the
present value of the coupon payments is:

1
1 1 r n
P=C

1
1

(1.04) 28

$0
0.04

1 2.998703319
$0

0.055

1 0.33477471

0.055

$0

= $0[16.66306322] = $0. [NOTE. We already knew the answer because the


coupon rate is zero.]

$1, 000
1.04 28

1+ r n
The present value of the par or maturity value of $1,000 is:

$1, 000
2.99870332

= $333.48. Thus, the price of the bond (P) = $0 + $333.48 = $333.48.

Q5 Page 56

a) Show the cash flows for the following four bonds, each of which has a par value of $1,000
and pays interest semiannually.
Bond
W
X
Y
Z

Coupon Rate (%)


7
8
9
0

Number of Years to Maturity


5
7
4
10

(b) Calculate the yield to maturity for the four bonds.


Hint: Use your calculator, make PV a negative #

Price
$884.20
$948.90
$967.70
$456.39

Period

Cash Flow
for Bond W

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

$35
$35
$35
$35
$35
$35
$35
$35
$35
$1,035

Cash Flow
for Bond
X
$40
$40
$40
$40
$40
$40
$40
$40
$40
$40
$40
$40
$40
$1,040

Cash Flow
for Bond Y

Cash Flow
for Bond Z

$45
$45
$45
$45
$45
$45
$45
$1,045

$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$1,000

b)
Bond W periodic rate 4.99% yield to maturity 10%
Bond Y p.r. 4.997% y.m. 10%
Bond X p.r. 4.49% y.m 9%
Bond Z p.r. 3.99 y.m. 8%

Q7 Page 56

7. Consider the following bond:


Coupon rate = 11%
Maturity = 18 years
Par value = $1,000
First par call in 13 years
Only put date in five years and putable at par value
Suppose that the market price for this bond $1,169.
(a) Show that the yield to maturity for this bond is 9.077%.
(b) Show that the yield to first par call is 8.793%.
(c) Show that the yield to put is 6.942%.

Q16 Page 56

16. Suppose that an investor with a five-year investment horizon is considering purchasing
a seven-year 9% coupon bond selling at par. The investor expects that he can reinvest the
coupon payments at an annual interest rate of 9.4% and that at the end of the investment
horizon two-year bonds will be selling to offer a yield to maturity of 11.2%. What is the
total return for this bond?
N=5*2=10 i=9.4/2=4.7 PMT=(1000*.09)/2=45 FV=? FV=558.14 This is the coupon
payments and the accrued interest on interest for the 5-year investment horizon
Step 2
PV5=? FV=par=1,000 i=11.2/2=5.6 PMT=45 n=2*2=4 PV 5=961.53
Total $ return is 558.14+961.53 = 1,519.67
Step 3
PV = 1,000 (this is your initial investment)
FV = 1,519.67 (this is your total $ return)
N= 5 years = 10 periods (this is your investment horizon)
Solving for I = 4.27% * 2 = 8.54%
8.54% is your final answer