Part A

What is the value of a 10-year, $1,000 par value bond with a 10% annual coupon if its
required return is 11.8%?

Part B
(1) What is the value of a 13% coupon bond that is otherwise identical to the bond
described in part A? Would we now have a discount or a premium bond?

(2) What is the value of a 7% coupon bond with these characteristics? Would we now
have a discount or a premium bond?
−𝑇
1 − (1+𝑅) 𝐹𝑉
𝑃𝑉 = 𝐶 × ⎡⎢ 𝑅
⎤ +
⎥ 𝑇
⎣ ⎦ (1+𝑅)
−10
1−(1+11.8%) 1,000
⇔ 𝑃𝑉 = 7% × 1000 × ⎡⎢ 11.8%
⎤ +
⎥ 10
⎣ ⎦ (1+11.8%)

⇔ 𝑃𝑉 = $726. 55
Because Price value of bone < Face value of bond ($726.55 < $1,000)
⇒ We would have a discount bond.

(3) What would happen to the values of the 7%, 10%, and 13% coupon bonds over
time if the required return remained at 11.8%?
The value of coupon bonds in 7%, the value equals $726.55
The value of coupon bonds in 10%, the value equals $897.46
The value of coupon bonds in 13%, the value equals $1,068.36

⇒ The value of coupon bonds in 7% and 10% would increase over time to face
value ($1,000), while the value of coupon bonds in 13% would decrease over time
to face value ($1,000) at the maturity date.
Part C
(1) What is the yield to maturity on a 10-year, 11.8% annual coupon, $1,000 par
value bond that sells for $887.00 (a)? That sells for $1,134.20 (b)?
T = 10
C% = 11.8%
FV = 1000
a) PV = $887
b) PV= $1,134.2
Explain:
a) C = 1000 × 11.8% = 118
−𝑇
1−(1+𝑅) ⎤ 𝐹𝑉
PV = C × ⎡⎢ 𝑅 ⎥+ 𝑇
⎣ ⎦ (1+𝑅)
−10
1−(1+𝑅) 1000
⇔ 887 = 118 × ⎡⎢ 𝑅
⎤+
⎥ 10
⎣ ⎦ (1+𝑅)

⇒ 𝑅 ≃ 13, 96% = 𝑌𝑇𝑀

b) C = 1000 × 11.8% = 118

−𝑟
1−(1+𝑅) ⎤ 𝐹𝑉
PV = C × ⎡⎢ 𝑅 ⎥+ 𝑟
⎣ ⎦ (1+𝑅)
−10
1−(1+𝑅) 1000
⇔ 1,134.2 = 118 × ⎡⎢ 𝑅
⎤+
⎥ 10
⎣ ⎦ (1+𝑅)

⇒ 𝑅 ≃ 9. 65%

(2) What is the total return, the current yield, and the capital gains yield for the
discount bond? Assume that it is held to maturity and the company does not default
on it.
C% = 11.8%
FV = 1000
Annual Coupon Payment = Coupon Rate x Par Value
= 11.8% x 1000
= 118
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑢𝑝𝑜𝑛 𝑃𝑎𝑦𝑚𝑒𝑛𝑡
Current Yield = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝐵𝑜𝑛𝑑
x 100
118
= 887
x 100

= 13.3%
 Total return = YTM = Current Yield + Capital Yield
=> Capital Yield = YTM - Current Yield
= 13.96% - 13.3%
= 0.66%

Part D
How does the equation for valuing a bond change if semiannual payments are made?
Find the value of a 10-year, semiannual payment, 10% coupon bond if nominal rd =
15.8%.
Annual Semiannual

YTM 15.8% 7.9%

T 10 20

Coupon rate 10% 5%

Coupon 100 50

Par value 1,000 1,000

𝑆𝑒𝑚𝑖𝑎𝑛𝑛𝑢𝑎𝑙 𝑏𝑜𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 =

1,000
20
1.079
+
50
0.079
× 1− ( 1
1.079
20 )
𝑆𝑒𝑚𝑖𝑎𝑛𝑛𝑢𝑎𝑙 𝑏𝑜𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 = 713. 14

Part E
Suppose for $1,000 you could buy a 12.8%, 10-year, annual payment bond or a
12.8%, 10- year, semiannual payment bond. They are equally risky. Which would
you prefer? If $1,000 is the proper price for the semiannual bond, what is the
equilibrium price for the annual payment bond?

*The semiannual payment bond would be preferred, explain:

(
EAR = 1 +
12.8%
2 ) 2
− 1 = 13.21%

⇒ The EAR of 13.21% is better than 12.8% , so the semiannual payment bond would be
preferred.

*The equilibrium price for the annual payment bond:

Bond formula :
−𝑇
1−(1+𝑅) 𝐹𝑉
PV = C × ⎡⎢ 𝑅
⎤+
⎥ −𝑇
⎣ ⎦ (1+𝑅)
−10
1−(1+13.21%) 1,000
⇔ PV = 12.8% × 1000 × ⎡⎢ 13.21%
⎤+
⎥ 10
⎣ ⎦ (1+13.21%)

⇒ PV = $977.94
At this price ($977.94), the annual and semiannual bonds would be in equilibrium
because investors would earn 13.21% on either bond.