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CA Final SFM Solve Questions On Bond Valuation by Prof GDTPE140 PDF
CA Final SFM Solve Questions On Bond Valuation by Prof GDTPE140 PDF
& Valuation
Solutions
Category of Problems
1. Bond Price…………………………………………………………………………………………………………...2
2. YTM Calculation……………………………………………………………………………………………… 14
3. Duration & Convexity of Bond ………………………………………………………………………… 30
4. Immunization…………………………………………………………………………………………………… 58
5. Forward Rates & Spot Rates Calculation…………………………………………………………... 66
6. Clean Price & Dirty Price…………………………………………………………………………………… 84
7. Bond Refunding Decision………………………………………………………………………………… 88
8. Convertible Bond…………………………………………………………………………….……………… 92
9. Mixed Problems……………………………………………………………………………………………… 102
Consider three bonds with 8 percent coupon rates, all selling at face value. The short-term
bond has a maturity of 4 years, the intermediate-term bond has maturity 8 years and the
long-term bond has maturity 30 years.
What will happen to the price of each bond if their yields increase to 9 percent? What will
happen to the price of each bond if their yields decrease to 7 percent?
What do you conclude about the relationship between time to maturity and the sensitivity
of bond prices to interest rates?
Solution
Coupon rate = 8%
Bond Maturity
1 – 4 Yrs
2 – 8 Yrs
3 – 30 Yrs
Bond 1
Solution
Since interest rates are expected to go down from 9% to 7% price will increase as per
Meikles theorem
1000 − 922.3
Capital gain =
922.3
= 𝟖. 𝟒𝟐%//
Solution
Bond A = 1294
Bond B = 1147
1294 − 1134.2
Bond A = = 𝟏𝟒. 𝟒%
1134.2
Bond B = 𝟏𝟒. 𝟕%
Solution
= 937.8
Problem #5
Consider a two-year Rs. 1000 face value 10% coupon rate bond which pays coupon semi-
annually. Find out the intrinsic value of the bond if the required rate of return is 14% p.a.
Compounded semi-annually. Should the bond be purchased at the current market price of
Rs. 965?
Solution
k k
Bond Price = Coupon ∗ PVIFA (( )%, 2n) + Bn ∗ PVIF (( )%, 2n)
2 2
Bond Price = 50 * PVIFA (7%, 4) + 1000* PVIF (7%,4)
Bond Price = 932.25
Since intrinsic Value (932.25)< Market Price (965) implies bond is trading at premium.
Hence bond should not be purchased at the current market price.
Solution
10
Current yield =
110
= 9.09%
If yield goes up by 1%
New Yield = 10.09%
10
Price =
10.09%
= 99.1080 //
k k
Bond Price = Coupon ∗ PVIFA (( )%, 2n) + Bn ∗ PVIF (( )%, 2n)
2 2
= 375*3.7171 + 10000*0.88848
= 10278.78 //
Solution
YTM = 16%
Redemption Price = 5% premium
Price of a bond = PV of future cash flows
9 9 9 9 10 10 10
= + 2 + 3 + 4 + 5 + + +
1.16 (1.16) (1.16) (1.16) (1.16) (1.16)6 (1.16)7
10 14 14 105
+ + +
(1.16)8 (1.16)9 (1.16)10 (1.16)10
Solution
Problem #9
A bond with 7.5% coupon interest – payable half yearly, Face Value 10,000 & Term to
maturity of 2 years in traded in the market. Find the Market Price of the Bond if the YTM is
10%. (Nov 2010)
Solution
k k
Bond Price = Coupon ∗ PVIFA (( )%, 2n) + Bn ∗ PVIF (( )%, 2n)
2 2
10 10
Bond Price = 375 ∗ PVIFA (( )%, 4) + 10000 ∗ PVIF (( )%, 4)
2 2
Solution
Solution
k k
Bond Price = Coupon ∗ PVIFA (( )%, 2n) + Bn ∗ PVIF (( )%, 2n)
2 2
Problem #12
The KLM bond has a 8% coupon rate, with interest paid semi-annually, a maturity value of
Rs. 1,000 and matures in 5 years. If the bond is priced to yield 6%, what is the bond’s
current price?
Answer – Price = Rs. 1085.2
Solution
k k
Bond Price = Coupon ∗ PVIFA (( )%, 2n) + Bn ∗ PVIF (( )%, 2n)
2 2
Problem #13
Consider the following information related to a bond:
Par Value Rs. 1000
Time to Maturity 15 Years
Coupon rate (interest payable annually) 8%
Current Market Price Rs. 847.88
Yield to Maturity (YTM) 10%
Other things remaining the same, if the bond starts paying interest semi-annually, find the
change in the market price of the bond.
Answer – New Price of Bond = Rs. 846.27
Solution
k k
Bond Price = Coupon ∗ PVIFA (( )%, 2n) + Bn ∗ PVIF (( )%, 2n)
2 2
Initially these bonds were issued at face value of Rs. 10,000 with yield to maturity of 8%.
Assuming that:
i. After 2 years from the date of issue, interest on comparable bonds is 10%, then what
should be the price of each bond?
ii. If after two additional years, the interest rate on comparable bond is 7%, then what
should be the price of each bond?
iii. What conclusions you can draw from the prices of Bonds, computed above.
Solution
Price of a floating rate bond remains same on every coupon reset date.
A 7% Bond issued several years ago when the market interest rate was also 7%. Now the
bond has a remaining life of 3 years when it would be redeemed at par value of Rs. 1,000.
The market rate of interest has increased to 8%. Find out the current market price, price
after 1 year and price after 2 years from today.
Solution
Problem #16
A Deep Discount Bond (DDB) was issued by a financial institution for a maturity period of
10 years and having a par value of Rs. 25,000. Find out the value of the Bond given that the
required rate of return is 16%.
Solution
Since the bond is a zero coupon bond coupon rate will be zero.
(b) A Company proposes to sell ten-year debentures of Rs. 10,000 each. The company
would repay Rs. 1,000 at the end of every year and will pay interest annually at 15 percent
on the outstanding amount. Determine the present value of the debenture issue if the
capitalization rate is 18 percent.
Solution
a)
Coupon
Intrinsic Value of Perpetual Bond =
YTM
14.5
Intrinsic Value of Perpetual Bond = = 90.625
0.16
Since market value>intrinsic value we can conclude that the bond is currently overpriced.
Hence the bond should not be purchased.
14.5
YTM = = 15.26%
95
b)
Solution
Coupon Rate = 7.5%
Maturity = 15 Yrs
Semiannual coupon payment
Bond is callable in 5 Yrs
YTM = 6%
Here since the price is greater we will solve it using higher rate YTM of 7% to get lower
price
= 6.28%
Solution
Here since the price is less we will solve it using lower rate YTM of 7.5% to get higher price
1228 .8.59−1165.75
YTC = 7.5% + x (8% - 7.5%)
1228 .8−1164
= 7.98%
There is a 9%, 5 year bond issue in the market. The issue price is Rs90 and the redemption
price is Rs105. For an investor with marginal income tax rate of 30% and capital gains tax
of 10% (assuming no indexation), what is the post tax yield to maturity?
Solution
Price of bond can be calculated as follows
@ YTM of 10%
Price = 88.1472
@ YTM of 9%
Price = 91.7727
Using Interpolation
91.77 − 90
YTM = 9% + x 9% - 8%
91.77 − 88.14
= 9.4876%
Solution
Maturity = 6 Yrs
Price = 95
Coupon = 13%
Using interpolation
96.11−95
YTM = 14% + * 1%
96.11−92.43
= 14.30%//
Solution
Using interpolation
100 − 97.6
YTM = 11% + ∗ (13% − 11%)
100 − 95.27
= 12%
Solution
Since intrinsic value of 1034.3 > is greater than market price of 1025.86 he should
consider investing in bonds.
150
b) Current yield =
1025 .86
= 14.62%//
c) YTM calculation
Calculation Price @ 14% = 1034.3
Price @ 15% = 1000
Using interpolation
PV @ Lower − Actual Desired
YTM = Low % + ∗ (High % − Low %)
PV @ Lower − PV @ Higher
= 14.23%. //
Solution
k k
Bond Price = Coupon ∗ PVIFA (( )%, 2n) + Bn ∗ PVIF (( )%, 2n)
2 2
1263.46 − 1147
YTM = 4% + ∗ (8% − 4%)
1263.46 − 1067.96
YTM = 6.38%//
Solution
(F − P)
C+
YTM = n
(F + P)
n
110000 − 90000
12000 +
= 20
110000 + 90000
2
= 𝟏𝟑. 𝟎𝟎%//
Solution
F−P
C+ n
YTM Approximate =
F+P
2
100 − 103.24
10 +
YTM = 4
203.24
2
= 𝟗. 𝟎𝟒%
= 1011
= 1045.9
13.5
YTC = 12% + ∗ 2%
13.5 + 21.4
Solution
= 449.4 − 360
= 89.4
When all dividends are spent that means no reinvestment income is received.
1000 = PVIF X, 4 ∗ 1000 + 360
= 𝟖%//
Solution
Bond 1
Coupon Received (C) = 5.65% * 10,000 = 565
Current Price (P) = 10,000 – (15% * 10,000) = 8,500
Redemption Amount (F) = 10,000
No of Years (n) = 4yrs
F−P
C+ n
YTM Approximate =
F+P
2
10,000 − 8,500
565 +
YTM Approximate = 4
10,000 + 8,500
2
Post Tax YTM = 10.16%
F−P
C+ n
YTM Approximate =
F+P
2
10,000 − 8,500
700 +
YTM Approximate = 6
10,000 + 8,500
2
Post Tax YTM = 10.27%
Bond 3
FV = PV ∗ (1 + Periodic Rate)n∗y
9
14,750 = 8,500 ∗ (1 + YTM)(4+12 )
YTM = 12.31%
Bond 4
FV = PV ∗ (1 + Periodic Rate)n∗y
9
17,800 = 8,500 ∗ (1 + YTM)(6+12 )
YTM = 11.57%
b)
Solution
YTM = 6%
Problem #30
A NOP bond has an 8% coupon rate (semi-annual interest), a maturity value of Rs. 1,000,
matures in 5 years, and a current price of Rs. 1,200. What is the NOP’s yield-to-maturity?
Answer – 3.6155%
Solution
Using interpolation
1230.55 − 1200
YTM = 3% + ∗ (5% − 3%)
1230.55 − 1131.28
= 3.6155%
Solution
Solution
a)
Coupon Payment After tax = Coupon * (10Tax Rate)
= 12% * 1000 (1-30%)
= 84
F−P
C+ n
YTM Approximate =
F+P
2
1086 − 960
84 +
YTM = 5
1086 + 960
2
= 𝟏𝟎. 𝟔𝟕%
b)
Year Coupon Cash Flow Principal Total Cash Flow
1 120 120
2 120 120
3 120 120
4 120 550 670
5 60 550 610
YTM=15%
Prof Manish Ramuka Topic – Bond Markets Page 28
Problem #33
IDBI, in its issue of Flexi bonds – 3, offered Growing Interest Bond. The interest will be paid
to the investors every year at the rates given below and the minimum deposits is Rs.
5000/-,
Year 1 2 3 4 5
Interest 10.5% 11.0% 12.5% 15.25% 18.0%
(p.a.)
Solution
YTM should be calculated in such a way that it satisfies the following equation
10.5% ∗ 5000 11% ∗ 5000 12.5% ∗ 5000 15.25% ∗ 5000 18% ∗ 5000
5000 = + + + +
1 + YTM 1 1 + YTM 2 1 + YTM 3 1 + YTM 4 1 + YTM 5
YTM=13%
Problem #34
Calculate duration of a six year bond whose face value is Rs1000 and which pays a coupon
of 8%. Assume the yield to be 8%.
Solution
Duration of bond =?
Total of Column 4
Duration =
Price
4992.88
=
1000
= 4.99288
= 5 Yrs //
Calculate duration of a semi annual coupon bond with an 8% coupon on 1000 face value
bond with 2 years to maturity and an YTM of 10%
Solution
YTM = 10%
1 2 3 4 - 3x2 5
Year CF PV Factor PV 4x1
0.5 40 0.9524 38.0960 19.0480
1 40 0.9070 36.2800 36.28
1.5 40 0.8638 34.5520 51.828
2 1040 0.8227 855.6080 1771.22
= 964.57 = 1818.37
1818.37
Duration =
964.57
Duration = 1.8852//
The face value of all bonds is Rs1000 and the YTM is 9%. Calculate the duration of the
portfolio. What would be the percentage change in price of bond 1 if the interest rates fall
to 7%? Also ascertain the percentage change in Portfolio value
Solution
5.3
Modified duration of portfolio =
(1+9%)
= 4.8624
10.6
% Change in bond 1 price = ∗2
(1 + 9%)
= 19.45%
Solution
Price = 160 x PVIFA (17%, 6) + 1000 X PVIF (17%, 6)
= 3.589 X 160 + 1000 X 0.390
= 964.24//
Duration Calculation
1 2 3 4
Yrs CF PV 1x2x3
1 160 0.8547 136.75
2 160 0.7305 233.76
3 160 0.6244 299.71
4 160 0.5337 341.56
5 160 0.4561 364.8
6 1160 0.3898 2713.6
= 4089.78
4089.78
Duration =
964.24
= 4.24 //
4.24
Modified Duration =
1+17%
= 3.6261 //
The modified duration for a 12 year 6% annual coupon bond yielding 7% is calculated to be
8.245.
a) If the yield falls to 6.8%, what is the percentage price change for this bond using the
modified duration value?
b) What is the actual percentage price change for this bond?
c) If the yield falls to 6.0%, what is the percentage price change for this bond using the
modified duration value?
d) What is the actual percentage price change for this bond?
Solution
a)
% change in price of bond = 0.2% X 8.245
= 1.6490%//
b)
Actual % change in price
935.77−920.57
% Change = X 100
920.57
= 1.65%//
Calculate Convexity given the following with respect to a coupon bond. Coupon rate = 6%,
Term = 5 years, Yield to maturity = 7% (3.5% semi-annual) and Price = 958.42.
Solution
1 2 3 4 5
Yrs Yrs (Yrs + 1) CF PVF 2x3x4
0.5 0.75 30 0.9662 21.73
1.0 2.00 30 0.9335 56.00
1.5 3.75 30 0.9019 101.46
2.0 6.00 30 0.8714 156.85
2.5 8.075 30 0.8420 221.00
3.0 12.00 30 0.8135 292.86
3.5 15.75 30 0.7860 371.38
4.0 20.00 30 0.7594 455.64
4.5 24.75 30 0.7337 544.77
5.0 30.00 1030 0.7089 21905
= 24126
24126
Convexity =
958.42 ∗ (1 + 7%)2
= 21.98//
Solution
a) Bond Price = C * PVIFA (k%, n) + Bn * PVIF (k%,n)
b) Duration
Yrs CF PV Factor 1x2x3
1 160 0.8547 136.75
2 160 0.7305 233.76
3 160 0.6244 299.71
4 160 0.5337 341.56
5 160 0.4561 364.88
6 1160 0.3898 2713.1
∑ 4089.5
4089.58
=
964.1082
=4.247 Years//
Macaulay Duration
c) Volatility =
(1+K)
4.247
=
1.17
= 3.63%//
Solution
Since price is lower than face value we select YTM to be higher than coupon rate.
Since above price is less than actual price we select next rate to be lower than 12%
Calculating bond price @ YTM of 11.5%
Bond Price = C * PVIFA (k%, n) + Bn * PVIF (k%,n)
Price = 968.7228
968.73 − 950
YTM = 12% + ∗ (12% − 11.5%)
968.73 − 948.61
YTM = 11.97%
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1 2 3 4 5
Yrs CF PV Factor @ PV (3x2) 4x1
11.97%
1 107.5 0.8931 96.00 96
2 107.5 0.7976 85.70 171.4
3 107.5 0.7123 76.56 229.68
4 107.5 0.6361 68.39 273.56
5 107.5 0.5682 61.08 305.4
6 1107.5 0.5074 561.9 3371.4
∑ 950 ∑ 4447.4
4447.4
Macaulay Duration =
950
= 4.6815//
Macaulay Duration
Modified Duration =
(1 + k)
4.6815
=
(1 + 11.97%)
= 4.1818//
Solution
Macualay Duration
Modified Duration =
k
(1 + 2)
6.72
=
12.5%
(1 + 2 )
6.72
=
1 + 6.25%
6.72
=
1.0625
= 6.3247
Problem #43
Four bonds are held by Ram (Durations and Proportion given below)
Bond Duration Proportion
A 4.50 years 0.20
B 3.00 years 0.25
C 3.50 years 0.25
D 2.80 years 0.30
What is the duration of Ram’s Bond Portfolio?
Solution
Portfolio Duration = Wi Di
Solution
Face value of a bond forms significant portion of cash flows from bond. Therefore longer
maturity bonds will return the cash flows later than a shorter maturity bond. Hence bonds
A, B, C will have higher duration than bond D. Bond D would be ranked last.
Zero coupon bonds do not give intermediate cash flows and the only cash flow from zero
coupon bond is its face value. This implies duration of a zero coupon bond is always higher
than the duration of coupon paying bond. Since bond B is a zero coupon bond with same
years to maturity as that of A & C, bond B will have higher duration as compared to A & C
and hence would be ranked first.
With all parameters same in 2 bonds, bond with higher yield to maturity will have lower
duration than a corresponding bond with a lower yield to maturity. This is because when
YTM is more, the reinvestment income is more and hence the cash flows from the bond is
received earlier since the coupons are reinvested at higher rates from the beginning. Hence
bond C with YTM equal to 7% is ranked second as compared to bond A which is ranked
third.
B, C, A, D
Solution
Since all the bonds have same maturity we will draw our conclusions from the relationship
between coupon rate and YTM
Bond C is a zero coupon bond and hence will have maximum duration.
Bond B & D have same coupon rate however have different YTM. Bond having higher YTM
will have lower duration. Hence Bond B has higher duration in comparison to bond D.
B>D
Bond A & B have same YTM, however they have different coupon rate. Bond having higher
coupon rate has lower duration. Hence Bond B has lower duration in comparison to A
Hence we have following relationship for duration of the bonds mentioned above.
C>A>B>D
Solution
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1 2 3 4 5
Yrs CF PV Factor @ PV (3x2) 4x1
10.0%
1 100 0.909 90.9 90.9
2 100 0.826 82.6 165.2
3 100 0.751 75.1 225.3
4 100 0.683 68.3 273.2
5 1100 0.621 683.1 3475.5
∑ 1000 ∑ 4170.1
Duration = 4.17yrs
Solution
t∗c n ∗ Bn
∑2n
t=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1 2 3 4 5
Yrs CF PV Factor @ PV (3x2) 4x1
10.0%
1 50 0.952 47.61905 47.61
2 50 0.907 45.35147 90.70
3 50 0.864 43.19188 129.57
4 50 0.823 41.13512 164.54
5 50 0.784 39.17631 195.88
6 50 0.746 37.31077 223.86
7 50 0.711 35.53407 248.73
8 50 0.677 33.84197 270.73
9 50 0.645 32.23045 290.07
10 1050 0.614 644.6089 6446.08
∑ 1000 ∑ 8107
8107
Macaulay Duration =
1000 ∗ 2
= 4.05
Solution
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1 2 3 4 5
Yrs CF PV Factor @ 7% PV (3*2) 4*1
5100
Macaulay Duration =
1000
= 5.1//
Solution
FV = 100000
YTM = 16%
Macaulay duration = 4.3202
t∗c n ∗ Bn
∑2n
t=1 +
(1 + k) (1 + k)t
t
Macaulay Duration =
B0
1𝐶 2𝐶 3𝐶 4𝐶 5𝐶 6𝐶 100000 ∗ 6
1.6 + 1.162 + 1.163 + 1.164 + 1.165 + 1.166 + 1.166
4.3202 =
3.685𝐶 + 41040
Price = 96943.14
Solution
FV = 100000
YTM = 8%
Macaulay duration = 4.992
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1𝐶 2𝐶 3𝐶 4𝐶 5𝐶 6𝐶 100000 ∗ 6
1.08 + 1.082 + 1.083 + 1.084 + 1.085 + 1.086 + 1.086
4.992 =
4.623𝐶 + 63000
Solving we get
C = 8000
Price = 1,00,000
Solution
N=5yrs
C=10%
YTM = 10%
Modified Duration = 3.79
Change in yield = -2%
Actual percentage price change is calculate by calculating price of a bond at new YTM of 8%
The answers are not same because duration is first derivative of the bond pricing formula
and assumes a linear relationship between price and yield. Actually the relationship is not
linear but convex which is explained by the concept of convexity which is second derivative
of bond pricing formulae and gives more accurate answer.
Solution
a)
Using interpolation
982.2 − 970
YTM = 12.5% + ∗ (14% − 12.5%)
982.2 − 931.4
= 12.84%
b)
YTM assumes that the intermediate cash flows are reinvested at the rate of YTM. This is not
always true as interest rates keeps on changing in the market, which could distort the
reinvestment income and hence change the realized YTM.
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1 2 3 4 5
Year Cashflow PV Factor @ 12.84% Present Value 4*1
1 120 0.8862 106 106
2 120 0.7854 94 188
3 120 0.6960 84 251
4 120 0.6168 74 296
5 1120 0.5466 612 3061
Total 970 3903
3903
Macaulay Duration = = 4.023
970
Solution
a)
1 2 3 4 5
Year Cashflow PV Factor @ 14% Present Value 4*1
1 C 0.8772 0.8772C 0.8772C
2 C 0.7695 0.7695C 1.5390C
3 C + 100000 0.6750 0.6750C + 67,500 2.025C+2,02,491
Total 2.3216C + 67,500 4.44C + 2,02,491
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
4.44C + 202491
2.6 =
2.3216C + 67500
C = 16,930
b)
Solution
F−P
C+ n
YTM Approximate =
F+P
2
1000 − 950
107.5 +
YTM Approximate = 6
1000 + 950
2
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1 2 3 4 5
Year Cash Flow PV Factor @ 11.96% Present Value (3 x 2) 4x1
1 107.5 0.8932 96.02 96.02
2 107.5 0.7978 85.76 171.52
3 107.5 0.7125 76.60 229.80
4 107.5 0.6364 68.42 273.66
5 107.5 0.5684 61.11 305.54
6 1107.5 0.5077 562.30 3373.79
Total 950.20 4450.32
4450
Macaulay Duration = = 4.684
950
Macaulay Duration
Modified Duration =
(1 + k)
4.684
=
(1 + 11.96%)
= 4.18//
Solution
F−P
C+ n
YTM Approximate =
F+P
2
1000 − 976.95
90 +
YTM Approximate = 6
1000 + 976.95
2
YTM Approximate = 𝟗. 𝟓%
YTM Actual = 9.52%
t∗c n ∗ Bn
∑nt=1 +
(1 + k) (1 + k)t
t
Macaulay Duration =
B0
1 2 3 4 5
Year Cash Flow PV Factor @ 9.52% Present Value (3 x 2) 4x1
1 90 0.9131 82.18 82.18
2 90 0.8337 75.03 150.07
3 90 0.7612 68.51 205.53
4 90 0.6951 62.56 250.22
5 90 0.6346 57.12 285.59
6 1090 0.5795 631.63 3789.81
Total 977.03 4763.40
Macaulay Duration
Modified Duration =
(1 + k)
4.875
=
(1 + 9.52%)
= 4.45//
Solution
966.47−960
YTC = 15% + x (15.5% - 15%)
966.47−950
= 15.2%
t∗c n ∗ Bn
∑nt=1 +
(1 + k) (1 + k)t
t
Macaulay Duration =
B0
1 2 3 4 5
Year Cash Flow PV Factor @ 9.52% Present Value (3 x 2) 4x1
1 140 0.8724 122.14 122.14
2 140 0.7611 106.55 213.10
3 140 0.6640 92.96 278.87
4 140 0.5793 81.10 324.38
5 140 0.5053 70.75 353.74
6 140 0.4409 61.72 370.33
7 140 0.3846 53.85 376.92
8 140 0.3355 46.98 375.80
9 140 0.2927 40.98 368.83
10 140 0.2554 35.75 357.52
11 140 0.2228 31.19 343.10
12 140 0.1944 27.21 326.53
13 140 0.1696 23.74 308.60
14 140 0.1479 20.71 289.94
15 140 0.1291 18.07 271.01
16 140 0.1126 15.76 252.19
17 140 0.0982 13.75 233.76
18 140 0.0857 12.00 215.93
19 140 0.0748 10.47 198.85
20 1140 0.0652 74.35 1486.92
Total 960.00 7068.46
7068
Macaulay Duration = = 7.363
960
Macaulay Duration
Modified Duration =
(1 + k)
7.363
=
(1 + 14.62%)
= 6.42//
Solution
In order to immunize any liability using bond portfolio in such a way that change in interest
rates will have no impact on the value of the portfolio, the duration of the portfolio should
be equal to the investment horizon or duration of the liability
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1 2 3 4=3x2 5
Yrs CF Discount Factor PV 4X1
1 80 0.8696 69.57 69.57
2 110 0.7561 83.18 166.35
3 60 0.6575 39.45 118.35
Total 192.19 354.27
354.27
Macaulay Duration = = 1.84
192.19
Hence we should create a portfolio of bonds in such a way that its duration is equal to
1.84yrs. Hencce the portfolio will be immunized to changes in interest rate movements.
Solution
In order to immunize any liability using bond portfolio in such a way that change in interest
rates will have no impact on the value of the portfolio, the duration of the portfolio should
be equal to the duration of the liability
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1 2 3 4=3x2 5
Yrs CF Discount Factor PV 4X1
1 30 0.8929 26.79 26.79
2 40 0.7972 31.89 63.78
3 20 0.7118 14.24 42.71
4 50 0.6355 31.78 127.10
Total 104.68 260.37
260.37
Macaulay Duration = = 2.49
104.68
Hence we should create a portfolio of bonds in such a way that its duration is equal to
2.49yrs. Hencce the portfolio will be immunized to changes in interest rate movements.
Since both the bonds are zero coupon bonds their duration will be equal to their maturity
2X+5Y = 2.49
X+Y = 1
X=83.67%
Y=16.63%
Solution
In order to immunize any liability using bond portfolio in such a way that change in interest
rates will have no impact on the value of the portfolio, the duration of the portfolio should
be equal to the duration of the liability
t∗c n ∗ Bn
∑nt=1 +
(1 + k) (1 + k)t
t
Macaulay Duration =
B0
1 2 3 4=3x2 5
Yrs CF Discount Factor PV 4X1
1 25.5 0.8929 22.77 22.76786
2 19.25 0.7972 15.35 30.69196
3 18.25 0.7118 12.99 38.96997
4 17.5 0.6355 11.12 44.48627
5 19.5 0.5674 11.06 55.32412
6 17.5 0.5066 8.87 53.19627
Total 82.16 245.44
245.44
Macaulay Duration = = 2.99
82.16
Hence we should create a portfolio of bonds in such a way that its duration is equal to
2.99yrs. Hencce the portfolio will be immunized to changes in interest rate movements.
F−P
C+ n
YTM Approximate =
F+P
2
Bond X
1050 − 966.38
110 +
YTM X = 5 = 12.72%
1050 + 966.38
2
Bond Y
950 − 988.66
130 +
YTM Y = 3 = 11.99%
950 + 988.66
2
Bond X
1 2 3 4=3x2 5
Yrs CF Discount Factor PV 4X1
1 110 0.8871 97.58 98
2 110 0.7870 86.57 173
3 110 0.6981 76.79 230
4 110 0.6193 68.13 273
5 1160 0.5494 637.31 3187
Total 966.38 3960.16
3960.16
Macaulay Duration = = 4.1
966.38
Bond Y
1 2 3 4=3x2 5
Yrs CF Discount Factor PV 4X1
1 130 0.8929 116.08 116
2 130 0.7973 103.65 207
3 1080 0.7120 768.93 2307
Total 988.66 2630.18
2630.18
Macaulay Duration = = 2.66
988.66
4.1X+2.66Y = 2.99
X+Y = 1
X=23%
Y=77%
Solution
In order to immunize any liability using bond portfolio in such a way that change in interest
rates will have no impact on the value of the portfolio, the duration of the portfolio should
be equal to the duration of the liability
264.31
Macaulay Duration = = 2.04
129.45
Hence we should create a portfolio of bonds in such a way that its duration is equal to
2.04yrs. Hencce the portfolio will be immunized to changes in interest rate movements.
2X+7Y = 2.04
X+Y = 1
Solving above 2 equations simultaneously we get
X=99.2%
Y=0.8%
The following corporate bonds are considered for investment by the portfolio manager. His
aim is to immunize the liability due in six years. All bonds have face value of Rs1000.
Bond Maturity Coupon Duration years
(Years) %
Arvind Mills 10 8 7.35
BILT 8 9 6.15
Cipla 5 7 4.30
If the portfolio manager wishes to invest 50% in Arvind Mills, What is the percentage of
total amount that can be invested in the other two bonds to immunize the portfolio?
Solution
In order to immunize the portfolio the duration of the portfolio should be equal to the
investment horizon
This implies
Portfolio duration = 6
i.e. 𝑊𝐴 𝐷𝐴 + 𝑊𝑆 𝐷𝐵 + 𝑊𝐶 𝐷𝐶 = 6
Solving we get
0.5 X 7.35 + 𝑊𝐵 X 6.15 + 𝑊𝐶 X 4.3 = 6
Also
𝑊𝐴 + 𝑊𝐵 + 𝑊𝐶 = 1
i.e. 𝑊𝐵 + 𝑊𝐶 =0.5
𝑊𝐵 = 9.5%
𝑊𝐶 = 40.5% //
Problem #62
If the 1 year spot is 5%, 1 year forward, starting one year from today is 6.5% and 1 year
forward starting two years from today is 8%, what is three year spot rate?
Solution
𝑆3 = ?
0 1 2 3
5 6.5 8
|-----------------------|-----------------------|--------------------------|
-------------------------------X----------------------------------
= 6.49%
Solution
(1 + S2 )2 = 1 + 1f0 ∗ 1 + 1f1
(1 + S2 )2 = 1 + 12% (1 + 11.25%)
3
1 + S3 = 1 + 1f0 ∗ 1 + 1f1 ∗ 1 + 2f1
3
1 + S3 = 1.12 1.1125 (1.1075)
C C C + FV
Price = + 2
+
(1 + S1 ) (1 + S2 ) 1 + S3 3
90 90 1090
Price = + +
(1 + 12%) 1 + 12% (1 + 11.25%) 1.12 1.1125 (1.1075)
= 942.48 //
Since β = 1.02
Price = 942.48*102
= 961.33 //
Solution
a)
Forward rate 1 year from today
(1 + S2 )2 = 1 + S1 ∗ 1 + 1f1
(1 + 11.25%)2 = (1 + 10.5%) (1 + X%)
1.11252
1 + X% = = 12%
1.105
Similarly
(1 + S3 )3 = 1 + S1 ∗ 1 + 1f1 ∗ (1 + 2f1 )
1 + 12% 3
1 + 2f1 =
(1.105 ∗ 1.12)
2f1 = 13.52%
b)
If bond is fairly priced then it implies its coupon rate is 12%.
This implies if interest rates increase by 50 basis points then YTM will be 12.5%
982.19 − 1000
% Change in bond price = = −𝟏. 𝟖%
1000
Solution
(1 + S3 )3 = 1 + S1 ∗ 1 + 1f1 ∗ (1 + 2f1 )
𝐒𝟑 = 𝟏𝟎. 𝟓𝟖%
Solution
n
Sn = 8.56 +
6
13 13 13 13 13 + 113
Bond Price = 1
+ 2
+ 3
+ 4
+
1.0873 1.0889 1.0906 1.0923 1.0939 5
F−P
C+
YTM Approximate = n
F+P
2
113 − 122.5
13 +
YTM = 5
113 + 122.5
2
= 𝟗. 𝟒𝟐%
t∗c n ∗ Bn
∑nt=1 +
(1 + k)t (1 + k)t
Macaulay Duration =
B0
1 2 3 4 5
Year Cash Flow PV Factor @ 9.42% Present Value (3 x 2) 4x1
1 13 0.9139 11.88 11.88
2 13 0.8352 10.86 21.72
3 13 0.7633 9.92 29.77
4 13 0.6976 9.07 36.28
5 126 0.6376 80.33 401.66
Total 122.06 501.30
501.3
Macaulay Duration =
122.06
= 4.11//
Macaulay Duration
Modified Duration =
(1 + k)
4.11
=
(1 + 9.42%)
= 3.75//
Solution
For zero coupon bonds bond price is calculated using following formula
FV
Price =
1 + Sn n
1 year bond
1000
930.23 =
(1 + S1 )
Solving we get S1 = 7.5%
2 year bond
1000
923.79 =
(1 + S2 )2
Solving we get S2 = 4.04%
3 year bond
1000
919.54 =
(1 + S3 )3
Solving we get S3 = 2.84%
Problem #68
Given the following spot rates for various periods of time from today, calculate forward
rates from years one to two, two to three and three to four.
S1 = 5%, S2 = 5.5%, S3 = 6.5%, S4 = 7%
Solution
1 year forward rate
(1 + S2 )2 = 1 + S1 ∗ 1 + 1f1
1 + 5.5% 2 = 1 + 5% 1 + 1f1
(1.055)2
(1 + 1f1 ) =
1.05
𝟏𝐟𝟏 = 𝟔%
Solution
(1 + S2 )2 = 1 + S1 ∗ 1 + 1f1
S2 = 1 + 10% 1 + 9.5 − 1
S2 = 9.75%
(1 + S3 )3 = 1 + S1 ∗ 1 + 1f1 ∗ (1 + 2f1 )
3
S3 = 1 + 10% 1 + 9.5% 1 + 9% − 1
S3 = 9.5%
Solution
For zero coupon bonds bond price is calculated using following formula
FV
Price =
1 + Sn n
1 year bond
1000
909.09 =
(1 + S1 )
Solving we get S1 = 10%
C C + FV
Price = +
(1 + S1 ) (1 + S2 )2
100 1100
991.81 = +
(1 + 10%) (1 + S2 )2
Solution
For zero coupon bonds bond price is calculated using following formula
FV
Price =
1 + Sn n
1000
S1 = − 1 = 7.07%
934
C C + FV
Price = +
(1 + S1 ) (1 + S2 )2
100 1100
985 = + 2
(1 + 7.07%) 1 + S2
Solution
n
Sn = 9.0 +
10
C C C + FV
Price = + +
(1 + S1 ) (1 + S2 )2 1 + S3 3
10 10 120
Bond Price = 1
+ 2
+ 3
1.091 1.092 1.093
2)
1 years forward Rate calculation
1 + S2 2 = 1 + S1 ∗ 1 + 1f1
1 + 9.2% 2 = 1 + 9.1% ∗ 1 + 2f1
Solving we get
1f1 = 9.3%
Solution
n
Sn = 9.0 +
10
C C C + FV
Price = + 2
+
(1 + S1 ) (1 + S2 ) 1 + S3 3
Find out the term structure of interest rates by the method of bootstrapping. Also, compute
the 1 Yr forward rates.
Answer - 𝐟𝟎𝟏 = 𝐫𝟎𝟏 = 10%, 𝐟𝟏𝟐 = 4.25%, 𝐟𝟐𝟑 = 7.54%, 𝐟𝟏𝟑 = 12.12%, 𝐫𝟎𝟏 = 10%, 𝐫𝟎𝟐 = 7.09%,
𝐫𝟎𝟑 = 7.24%
Solution
1100
S1 = − 1 = 10%
100
Solution
925 ∗ 1 + S4 4 = 1000
Solving we get
S4 = 1.968%
900 ∗ 1 + S5 5 = 1000
Solving we get
S5 = 2.13%
1 + S5 5 = 1 + S4 4 ∗ (1 + 4f1 )
Solving we get 4f1 = 2.78%
Answer - 𝐫𝟎𝟏 = 11.11%, 𝐫𝟎𝟐 = 11.8%, 𝐫𝟎𝟑 = 12.6%, 𝐟𝟎𝟏 = 11.11%, 𝐟𝟏𝟐 = 12.49%, 𝐟𝟐𝟑 =
14.22%, 𝐟𝟏𝟑 = 28.49%
Solution
For zero coupon bonds bond price is calculated using following formula
FV
Price =
1 + Sn n
Solution
1,00,000
S1 = −1
91,500
C C + FV
Price = +
(1 + S1 ) (1 + S2 )2
10,000 1,10,000
98,500 = +
(1 + 9.23%) 1 + S2 2
Solution
1,00,000
S1 = −1
91,000
C C + FV
Price = +
(1 + S1 ) (1 + S2 )2
10,500 1,10,500
99,000 = +
(1 + 9.89%) 1 + S2 2
Problem #79
Solution
a)
YTM as of January 1, 2000
Since the bonds were sold @ Par
YTM = CR
= 10%
b)
Step1: Calculate clean price on next coupon date i.e on 30/June/2008
k k
Bond Price = Coupon ∗ PVIFA (( )%, 2n) + Bn ∗ PVIF (( )%, 2n)
2 2
12 12
Clean Price = 50 ∗ PVIFA (( )%, 2 ∗ 7.5) + 1000 ∗ PVIF ( )%, 2 ∗ 7.5)
2 2
952.87
Dirty Price = = 916.22
1 + 6% 4/6
Solution
1,00,646.55
Dirty Price = = 90,630.74
1 + 15% 9/12
However the actual price quoted in the market is 92,550 which is greater than intrinsic
value. So the bond is trading rich and investor should go short.
Solution
k k
Bond Price = Coupon ∗ PVIFA (( )%, 2n) + Bn ∗ PVIF (( )%, 2n)
2 2
1195.5
Dirty Price = = 1161.16
1 + 6% 3/6
Since the market price 1030 is less than intrinsic value the bond is trading cheap and
investor should go long
Problem #82
Solution
Premium cost & unamortized cost of old bonds will be deducted now in income statement
which will lead to tax savings.
There will be savings on coupon also as new coupon is leaser compared to old
Difference in coupon = 300 (12% - 10%)
= 6mn
Because of new bonds issuance cost of 6mn there will be tax benefits.
New bond will be amortized (i.e. its issuance cost will be amortized over next 6 years
9
= 0.3 * (PVIFA) (7%, 6)
6
= 2.14mn
Solution
Time to maturity = 10 Years
Outstanding Value = 2 Cr
Coupon Rate = 11%
PV of total savings
= 2.8 * PVIFA (7%, 10)
= 19.66602
g) Savings on tax due to amortization of issuance cost
2.5−3
= * 0.3 x PVIFA (7%, 10)
10
= -0.1054L
Solution
FV = 1000
Price = 1350
CR = 10.5%
Conversion rate = 14 Shares
CMP = 1475
Share Price = 80
Conversion Premium is % increase in price required from CMP to reach to conversion price
= 105.3571
= 31.7% //
Solution
Coupon Rate = 12
Conversion ratio = 20
FV = 100
Maturity = 5 yrs
Solution
265−235
=
235
= 12.77%
= 10.42%
= 13.25
Solution
Conversion ratio = 10
OR
5400 −(430∗10)
=
(430∗10)
= 25.58% //
Solution
1500
Conversion price = = 75
20
(75 − 60)
Conversion Premium = ∗ 100
60
Solution
a)
Conversion Value Stock Value = Current Market Price ∗ Conversion Ratio
= 30*25
= 750//
b)
Market Price of Bond
Conversion price =
Conversion Rate
925
Conversion price = = 37
25
c)
(Conversion Price – Current Share Price)
Conversion Premium =
Current Share Price
(37 − 30)
Conversion Premium = ∗ 100 = 23.33%
30
d)
(Market Price of Bond – Straight Value of Bond )
Premium over straight value =
Straight Value of Bond
(925 − 730)
Premium over straight value = ∗ 100 = 26.71%
730
Solution
a)
Conversion Value Stock Value = Current Market Price ∗ Conversion Ratio
= 25*30
= 750//
b)
Market Price of Bond
Conversion price =
Conversion Rate
900
Conversion price = = 30
30
c)
(Conversion Price – Current Share Price)
Conversion Premium =
Current Share Price
(30 − 25)
Conversion Premium = ∗ 100 = 20%
25
d)
(Market Price of Bond – Straight Value of Bond )
Premium over straight value =
Straight Value of Bond
(900 − 700)
Premium over straight value = ∗ 100 = 28.57%
700
You are required to calculate (i) the conversion premium and 9ii) the conversion value.
Solution
a)
b)
(Conversion Price – Current Share Price)
Conversion Premium =
Current Share Price
(540 − 480)
Conversion Premium = ∗ 100 = 12.50%
480
c)
Conversion Value Stock Value = Current Market Price ∗ Conversion Ratio
= 480*20
= 9600//
Solution
Solution
Problem #94
Solution
14
a)Current Yield =
90
= 15.5%
We solve it by trial & error and then use interpolation to get to correct answer.
At 15% At 18%
Price = 96.64 Price = 87.49
96.64−90
YTM = 15% + * 3%
96.64−87.49
= 15% + 2.177%
= 17.17%
14∗ 5 + 100
= (1 + X)5
90
1.8889 = (1 + X)5
Solving we get
X = 13.56%
Solution
a)
5 Year Bond
Bond Price = C * PVIFA (k%, n) + Bn * PVIF (k%,n)
= 80 * PVIFA (6%, 5) + 1000 * PVIF (6%, 5)
= 1083.96
Hence
= 78.6%
% change in bond price due to coupon = 21.4%
b)
5097.74
Duration =
1000
= 5.097 Years
C)
If YTM increase to 10%
New Price
= 70 * PVIFA (10%, 6) + 1000 * PVIF (10%, 6)
= 868.85
New duration can be calculated as follows as only discounting factor will change
4366 .45
New Duration = 5.2025 Years
868.85
Solution
Coupon earned at the end of year 1 = 10% of 1000
= 100
If reinvestment rates increase to 12% then interest earned on interest = 12% of 100
= 12
Solution
Step I
Fund PV of bond today
n = 10
FV = 1000
I/Y = 10%
PMT = 80
Step III
Coupon payments @ end of Year
1 = 80 ∗ 1.0953 = 105.03
2 = 80 ∗ 1.0952 = 95.9
3 = 80 ∗ 1.0951 = 87.6
4 = 80 ∗ 10.950 = 80
Total = 368.53
446.56
% 𝑔𝑎𝑖𝑛 =
877.1087
= 50.91%
Prof Manish Ramuka Topic – Bond Markets Page 107
Step IV
Gain because of investment income
= 368.56 − 320
= 48.56
Step V
Gain because of coupons
= 80 ∗ 4
= 320
Step VI
Gain because of decrease in yield
Price of bond w/o change in yield at the end of 4 years
= 80 ∗ PVIFA 10%, 6 + 1000 ∗ PVIF 10%, 6
= 912.89
Solution
Solving for a
Bond Price = C * PVIFA (k%, n) + Bn * PVIF (k%,n)
Bond Price = 0 + 1000 * PVIF(10%,5)
a = 1000 * 0.621
a = 621
Solving for b
1000
312 =
(1 + b)20
We can either solve the above equation using interpolation or we can look at the PVIF table
for value of 0.312 for 20 yrs
Solving for c
1000
315 =
(1 + 8%)c
We can either solve the above equation using interpolation or we can look at the PVIF table
for value of 0.315 for 8%.
Solution
However since the YTM and coupon rate is same the Bond Price today is same as face value
which is equal to 1000
In order to calculate YTC we can use approximate formula or we can use interpolation
F−P
C+ n
YTC Approximate =
F+P
2
1050 − 1000
100 +
YTC Approximate = 3
1050 + 1000
2
Solution
Solution