Problem set 2

Topic: Bond Valuation

Submitted by:

Anusha Goel PGP/25/137

Apoorva Trivedi PGP/25/138
Lalit Saraswat PGP/25/151

1. A $1000 par value bond has the following features: a coupon of 8% paid semiannually
and maturing in ten years. What is the bond price if comparable bonds yield (in terms of
APR) 8%? 10%? Why are prices different @ 8% and 10% YTM?
Answer 1

FV 1000
Years 10
Coupon rate 8%
Coupon annually 80
Interest rate case1 8% 4% semiannually
Interest rate case 2 10% 5% semiannually

PV case 1 -1000.00 PV(4%,20,40,1000)

PV case 2 -875.38 PV(5%,20,40,1000)

In case 1 the bond is trading at par, while in case 2 market interest rate are higher thus lesser bond price

2. Terminator Bug, Inc. just sold an issue of 30-year bonds for $1,107.20. Investors require
a rate of return on these bonds of 7.75% PA compounded HY. The bonds pay interest
semiannually. What is the coupon rate of the bonds?
Answer 2
Present value 1107.2
Face value 1000
Years 30
YTM 7.75% 3.875% Half yearly

Coupon Interest given semiannually 43.38 PMT(3.875%,60,-1107.2,1000)

Annual Coupon given 86.75
Coupon rate 8.68% Paid semiannually

3. Zero Sword has a $1,000 par value bond that is currently selling for $1,300. It has an
annual coupon rate of 7%, paid semiannually, and has nine years remaining until
maturity. What is the annual yield to maturity on the bond?

Answer 3
Face Value 1000
Present value 1300
Coupon rate 7%
Coupon Interest 70
Years 9
Rate 1.57% Semiannually Rate(18,35,-1300,1000)
YTM 3.15%

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4. A company has two bonds outstanding. The first maturing in 5 years with a coupon of
8.25% and the second in ten years bears a coupon of 8.25%. What is the price of these
two bonds? Why are they different? Assume YTM as 10% and FV as $1000.
Answer 4
Coupon rate 8.25%
FV 1000
YTM 10%
Time period 1 5
Time period 2 10

Price bond 1 -933.66 Longer the maturity more is the price change
Price bond 2 -892.47

5. Consider the two following bonds:

Assume you own both the bonds A and B, if rates are likely to rise on which bond will you
lose more?

bond coupon Maturity years

A 8% 10
B 14% 10

If you own both the bonds X and Y, if rates are likely to fall on which bond will you
gain less?

bond coupon Maturity years

X 18% 10
Y 18% 15

Answer 5
Bond Coupon Maturity years
A 8% 10
B 14% 10

Bond A will loose more if rates are likely to rise as of Malkiel theorem 4

Bond Coupon Maturity years

X 18% 10
Y 18% 15

On bond X we will gain less as less the maturity less is the Price change as per Malkiel theorem 5

6. Which of the following bonds is the most interest rate sensitive bond?

bond coupon Maturity years

A 8% 10
B 12% 10
C 8% 5

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 Answer 6
Bond Coupon Maturity years
A 8% 10
B 12% 10
C 8% 5

Out of bond A and C, A is more interest rate sensitive because of longer maturity
Out of bond A and B, A is more interest rate sensitive because of lower rates

Thus, A is most sensitive to interest rate changes

7. What is the duration of a two-year bond that pays an annual coupon of 10% and has a
current YTM of 12%? Use $1000 as the face value.
Answer 7
Year Cashflows Present Value Weighted PV
1 100 -89.29 -89.29
2 1100 -876.91 -1753.83
Total -966.20 -1843.11
Duration (Years) 1.91 Weighted Pv/Pv

YTM 12%
Face value 1000

8. Yankee Inc. has sold a security to raise new funds. Unlike ordinary bonds, it pays no par
value/face value at the end of its life. It only pays coupons every year as follows: $100(1
+ 0.05) at the end of year one, $100(1 + 0.05) 2 at the end of year two, and so on. This
security lasts for 4 years (i.e., makes 4 payments). The current interest rate is 5% for all
maturities. What is the price today of this new security? What is the Mac duration of this
bond?
Answer 8
Years Cashflows Present value Weighted PV
1 105.00 -100.00 -100
2 110.25 -100.00 -200
3 115.76 -100.00 -300
4 121.55 -100.00 -400
Total -400.00 -1000

YTM 5% Duration (Years) 2.50 Weighted Pv/Pv

Current Price 400

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9. Find the change in bond prices as predicted by duration when rates are likely to change
by 1.5%.
Duratio
YTM BP Coupon Term n
10% 100 10% 20 9.36 yrs

Answer 9
YTM 10%
BP 100
Coupon 10%
Term 20 PV -100.00
Duration 9.36

Modified duration 8.51

Price change 12.76% For both increase and decrease in interest rates

Actual Price change when Interest increases 1.5% 11.56 Percent

PV here -88.44

Actual Price change when Interest decrease 1.5% 14.20 Percent

PV here -114.20

10. Suppose that you purchase a bond that matures in five years and pays a 13.76% coupon.
The bond is priced to yield 10%. What is the duration of the bond? Is it equal to five
years? What will be the rate of return earned by you if interest rates rise to 11% next year
and stays there for the remaining period of your investment horizon (the total length of
time that an investor expects to hold a security).
Answer 10 Years Cashflows PV Weighted PV Under 11% interest from Yr 2 In Case of reinvestment
1 13.76 -12.51 -12.51 -12.51 20.89
2 13.76 -11.37 -22.74 -11.17 18.82
3 13.76 -10.34 -31.01 -10.06 16.95
4 13.76 -9.40 -37.59 -9.06 15.27
5 113.76 -70.64 -353.18 -67.51 113.76
Total -114.25 -457.04 -110.31 Total 185.69
PV 114.25
YTM 10.00% Duration 4.00 Rate 10.20%

New Interest rate 10.972%

11. A 6% 5-year coupon paying bond with a par value of $1000 is trading at an YTM of 9%.
What is the modified duration of the bond?

a. If the YTM changes by 50 bp what will be the actual change in the bond price?
What will be the change in the bond price as per MD rule? What is the percentage
error?
b. If the YTM changes by 250 bp what will be the actual change in the bond price?
What will be the change in the bond price as per MD rule? What is the percentage
error?

Compute the changes for both increase and decrease in rates, tabulate your results, and
explore the reasons.

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 Answer 11

Face Value 1000

Bond rate 6%
Year 5
YTM 9%

Year Cashflows PV PV weighted

1 60 -55.05 -55.05
2 60 -50.50 -101.00
3 60 -46.33 -138.99
4 60 -42.51 -170.02 Price change Percentage Price change
5 1060 -688.93 -3444.64 PV -883.31
Total -883.31 -3909.70 Case A increase -865.61 17.70 2.00%
Case A decrease -901.48 18.17 2.06%
Duration (yr) 4.43 Case B increase -799.26 84.05 9.52%
Case B decrease -979.22 95.91 10.86%
Modified Duration 4.06

Price change as of m.d. Actual Price change Percentage error

Case A inc 2.03 2.00 1.48%
dec 2.06 1.48%
Case B inc 10.15 9.52 6.22%
dec 10.86 6.98%

This is because the actual Price curve us convex and the larger the change in interest rate more error is there in Price calculated via modified duration
The error is more for decrease and less for increase as m.d. overestimate loses and underestimate gains

12. Liz owns a portfolio of four bonds given below:

Duration Investment
R 4.5 yrs 1850
S 3.0 1600
T 3.5 1450
V 2.8 2300
What is the duration of Liz’s bond portfolio?
Answer 12
Duration Investment Proprtion Porportion*duration
R 4.5 1850 0.26 1.16
S 3 1600 0.22 0.67
T 3.5 1450 0.20 0.70
V 2.8 2300 0.32 0.89
Total 7200 3.42

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13. AllSeason Furniture, Inc. issued an 8 percent 15-year bond five years ago. The bond is
selling now for $1,232. Given that the bond’s face value is 1,000 and that the coupon
payments are made annually, what is the AllSeason’s bondholders’ expected return on
the bond?

Answer 13

PV after 5 yrs 1232

Time remaining 10 yrs
Coupon interest 80
Face value 1000

Expected rate of return 5% RATE(10,80,-1232,1000)

14. Thalin Inc. has decided to extend its current product line. To finance the project, the firm
is considering issuing a 10-year, 1000 face value bond. Two years ago the firm issued a
12-year, 1000 face value, 10% coupon bond to finance a similar project. The current
market price of the bond is 1064.5. At what rate should the firm issue the new bond?

Answer 14
Face value 1000
Time period total 12 yrs
Time period remaining 10 yrs
Coupon rate 10%
Coupon paid 100
PV 1064.5

For new bonds to sell at par value, their coupon rate be equal to current rate of market

Current market rate 9%