CHAPTER 5

INTEREST RATES AND BOND

VALUATION
Calculator Solutions

1.
a.
Enter 34 2% $1,000
N I/Y PV PMT FV
Solve for $510.03

b.
Enter 34 5% $1,000
N I/Y PV PMT FV
Solve for $190.35

c.
Enter 34 7% $1,000
N I/Y PV PMT FV
Solve for $100.22

2.
a.
Enter 46 3.5% $35 $1,000
N I/Y PV PMT FV
Solve for $1,000.00

b.
Enter 46 4.5% $35 $1,000
N I/Y PV PMT FV
Solve for $807.12

c.
Enter 46 2.5% $35 $1,000
N I/Y PV PMT FV
Solve for $1,271.54

3.
Enter 26 ±$1,050 $25.50 $1,000
N I/Y PV PMT FV
Solve for 2.293%
2.293%  2 = 4.59%
4.
Enter 25 3.2% ±$1,040 $1,000
N I/Y PV PMT FV
Solve for $34.35
$34.35  2 = $68.70
$68.70/$1,000 = .0687, or 6.87%

5.
Enter 16 3.4% €47 €1,000
N I/Y PV PMT FV
Solve for €1,158.41

6.
Enter 18 ±¥103,250 ¥4,900 ¥100,000
N I/Y PV PMT FV
Solve for 4.63%

16. Miller Corporation

P0
Enter 26 3.1% $41 $1,000
N I/Y PV PMT FV
Solve for $1,176.73

P1
Enter 24 3.1% $41 $1,000
N I/Y PV PMT FV
Solve for $1,167.55

P3
Enter 20 3.1% $41 $1,000
N I/Y PV PMT FV
Solve for $1,147.41

P8
Enter 10 3.1% $41 $1,000
N I/Y PV PMT FV
Solve for $1,084.87

P12
Enter 2 3.1% $41 $1,000
N I/Y PV PMT FV
Solve for $1,019.11

Modigliani Company
P0
Enter 26 4.1% $31 $1,000
N I/Y PV PMT FV
Solve for $841.90
P1
Enter 24 4.1% $31 $1,000
N I/Y PV PMT FV
Solve for $849.08

P3
Enter 20 4.1% $31 $1,000
N I/Y PV PMT FV
Solve for $865.29

P8
Enter 10 4.1% $31 $1,000
N I/Y PV PMT FV
Solve for $919.29

P12
Enter 2 4.1% $31 $1,000
N I/Y PV PMT FV
Solve for $981.17

17. If both bonds sell at par, the initial YTM on both bonds is the coupon rate, 6.5 percent. If the YTM
suddenly rises to 8.5 percent:
PLaurel
Enter 8 4.25% $32.50 $1,000
N I/Y PV PMT FV
Solve for $933.36
PLaurel% = ($933.36 – 1,000)/$1,000 = –6.66%

PHardy
Enter 46 4.25% $32.50 $1,000
N I/Y PV PMT FV
Solve for $799.39
PHardy% = ($799.39 – 1,000)/$1,000 = –20.06%

If the YTM suddenly falls to 4.5 percent:

PLaurel
Enter 8 2.25% $32.50 $1,000
N I/Y PV PMT FV
Solve for $1,072.47
 PLaurel % = ($1,072.47 – 1,000)/$1,000 = +7.25%

PHardy
Enter 46 2.25% $32.50 $1,000
N I/Y PV PMT FV
Solve for $1,284.74
 PHardy % = ($1,284.74 – 1,000)/$1,000 = +28.47%
All else the same, the longer the maturity of a bond, the greater is its price sensitivity to changes in
interest rates.
18. Initially, at a YTM of 9 percent, the prices of the two bonds are:

PFaulk
Enter 28 4.5% $28.50 $1,000
N I/Y PV PMT FV
Solve for $740.24

PGonas
Enter 28 4.5% $61.50 $1,000
N I/Y PV PMT FV
Solve for $1,259.76

If the YTM rises from 9 percent to 11 percent:

PFaulk
Enter 28 5.5% $28.50 $1,000
N I/Y PV PMT FV
Solve for $625.78
PFaulk% = ($625.78 – 740.24)/$740.24 = –15.46%

PGonas
Enter 28 5.5% $61.50 $1,000
N I/Y PV PMT FV
Solve for $1,091.79
PGonas% = ($1,091.79 – 1,259.76)/$1,259.76 = –13.33%

If the YTM declines from 9 percent to 7 percent:

PFaulk
Enter 28 3.5% $28.50 $1,000
N I/Y PV PMT FV
Solve for $885.16
PFaulk% = ($885.16 – 740.24)/$740.24 = +19.58%

PGonas
Enter 28 3.5% $61.50 $1,000
N I/Y PV PMT FV
Solve for $1,468.18
PGonas% = ($1,468.18 – 1,259.76)/$1,259.76 = +16.54%

All else the same, the lower the coupon rate on a bond, the greater is its price sensitivity to
changes in interest rates.

19.
Enter 22 ±$1,080 $32 $1,000
N I/Y PV PMT FV
Solve for 2.712%
YTM = 2.712%  2 = 5.42%
20. The company should set the coupon rate on its new bonds equal to the required return; the required
return can be observed in the market by finding the YTM on outstanding bonds of the company.

Enter 40 ±$1,121.80 $32 $1,000

N I/Y PV PMT FV
Solve for 2.698%
2.698%  2 = 5.40%

23. Current yield = .0695 = $63/P0 ; P0 = $906.47

Enter 7.14% ±$906.47 $63 $1,000

N I/Y PV PMT FV
Solve for 22.9760

24.
Enter 26 ±$1,043.55 $27 $1,000
N I/Y PV PMT FV
Solve for 2.471%
2.471% × 2 = 4.94%
26.
Bond P
P0
Enter 8 7% $84 $1,000
N I/Y PV PMT FV
Solve for $1,083.60

P1
Enter 7 7% $84 $1,000
N I/Y PV PMT FV
Solve for $1,075.45
Current yield = $84/$1,083.60 = 7.75%
Capital gains yield = ($1,075.45 – 1,083.60)/$1,083.60 = –.75%

Bond D
P0
Enter 8 7% $56 $1,000
N I/Y PV PMT FV
Solve for $916.40

P1
Enter 7 7% $56 $1,000
N I/Y PV PMT FV
Solve for $924.55
Current yield = $56/$916.40 = 6.11%
Capital gains yield = ($924.55 – 916.40)/$916.40 = .89%

All else held constant, premium bonds pay a higher current income while having price depreciation as
maturity nears; discount bonds pay a lower current income but have price appreciation as maturity
nears. For either bond, the total return is still 7 percent, but this return is distributed differently between
current income and capital gains.
27.
a.
Enter 21 ±$865 $55 $1,000
N I/Y PV PMT FV
Solve for 6.72%
This is the rate of return you expect to earn on your investment when you purchase the bond.

b.
Enter 19 4.50% $55 $1,000
N I/Y PV PMT FV
Solve for $975.15

The HPY is:

Enter 2 ±$865 $55 $975.15

N I/Y PV PMT FV
Solve for 12.36%
The realized HPY is greater than the expected YTM when the bond was purchased because interest
rates dropped by 1 percent; bond prices rise when yields fall.
28.
PM
CFo $0
C01 $0
F01 12
C02 $800
F02 16
C03 $1,000
F03 11
C04 $21,000
F04 1
I = 2.95%
NPV CPT
$17,791.23

PN
Enter 40 2.95% $20,000
N I/Y PV PMT FV
Solve for $6,251.38

31.

Enter 30 1.92% $22,400

N I/Y PV PMT FV
Solve for $39,637.09

Enter 30 3.05% $97,500

N I/Y PV PMT FV
Solve for $39,637.09
32.
Real return: 1 + .055 = (1 + r)(1 + .029); r = 2.53%
Enter 2.53% 12
NOM EFF C/Y
Solve for 2.50%

Enter 52 × 30 2.50%/52 $5
N I/Y PV PMT FV
Solve for $5,489.44

33.
Real return for stock account: 1 + .12 = (1 + r)(1 + .04); r = 7.6923%
Enter 7.6923% 12
NOM EFF C/Y
Solve for 7.4337%

Real return for bond account: 1 + .07 = (1 + r)(1 + .04); r = 2.8846%

Enter 2.8846% 12
NOM EFF C/Y
Solve for 2.8472%

Real return post-retirement: 1 + .08 = (1 + r)(1 + .04); r = 3.8462%

Enter 3.8462% 12
NOM EFF C/Y
Solve for 3.7800%

Stock portfolio value:

Enter 12 × 30 7.4337%/12 $700
N I/Y PV PMT FV
Solve for $930,791.53

Bond portfolio value:

Enter 12 × 30 2.8472%/12 $325
N I/Y PV PMT FV
Solve for $184,509.85

Retirement value = $930,791.53 + 184,509.85 = $1,115,301.37

Retirement withdrawal:
Enter 25 × 12 3.7800%/12 $1,115,301.37
N I/Y PV PMT FV
Solve for $5,752.32

The last withdrawal in real terms is:

Enter 30 + 25 4% $5,752.32
N I/Y PV PMT FV
Solve for $49,736.70
34.
Future value of savings:
Year 1:
Enter 4 9% $376,956
N I/Y PV PMT FV
Solve for $532,104.16

Year 2:
Enter 3 9% $417,419.44
N I/Y PV PMT FV
Solve for $540,570.28

Year 3:
Enter 2 9% $461,714.60
N I/Y PV PMT FV
Solve for $548,563.12

Year 4:
Enter 1 9% $510,195.58
N I/Y PV PMT FV
Solve for $556,113.18

Future value = $532,104.16 + 540,570.28 + 548,563.12 + 556,113.18 + 563,249.03

Future value = $2,740,599.77

He will spend $400,000 on a luxury boat, so the value of his account will be:

Value of account = $2,740,599.77 – 400,000

Value of account = $2,340,599.77

Enter 25 9% $2,340,599.77
N I/Y PV PMT FV
Solve for $238,287.69