Exercise 5 (Solutions)

1. The Petit Chef Co. has 7 percent coupon bonds on the market with nine years left to
maturity. The bonds make annual payments and have a par value of $1,000. If the bonds
currently sell for $1,038.50, what is the YTM?
a) Please write down an equation to solve for YTM.
b) How do you use the Excel function YIELD(Settlement, Maturity, Rate, Pr,
Redemption, Frequency) or RENDEMENT.TITRE(…) in the French version to
calculate YTM? What should you fill in for Settlement, Maturity, Rate, Pr,
Redemption, Frequency respectively?
Please find below the description for the inputs of YIELD(Settlement, Maturity, Rate, Pr,
Redemption, Frequency).
Settlement The security's settlement date.
Maturity The security's maturity date.
Rate The security's annual coupon rate.
Pr The security's price per $100 face value.
Redemption The security's redemption value per $100 face value.
Frequency The number of coupon payments per year. For annual payments, frequency =
1; for semiannual, frequency = 2; for quarterly, frequency = 4.

Note that Dates should be entered by using the DATE function. For example, use
DATE(2008,5,23) for the 23rd day of May, 2008.

Answer:
a) Here, we need to find the YTM of a bond. The equation for the bond price is:

P = $1,038.50 = $70*({1 – [1/(1 + R]9 }/R) + $1,000*1/(1 + R)9.

Notice the equation cannot be solved directly for R. Using a spreadsheet, a financial calculator, or
trial and error, we find:

YTM = R

b) Given the bond information, the inputs for YIELD function should be
Settlement =DATE(2020,1,1)
Maturity =DATE(2029,1,1)
Rate 7%
Pr 103.85
Redemption 100
Frequency 1

After applying YIELD function in the Excel with above inputs, you will get YTM = 6.42%.
2. Parkway Void Co. issued 15-year bonds two years ago at a coupon rate of 5.4 percent.
The bonds make semiannual payments. If these bonds currently sell for 106 percent of par
value, what is the YTM?
a) Please write down an equation to solve for YTM.
b) How do you use the Excel function YIELD(Settlement, Maturity, Rate, Pr,
Redemption, Frequency) or RENDEMENT.TITRE(…) in the French version to calculate
YTM? What should you fill in for Settlement, Maturity, Rate, Pr, Redemption, Frequency
respectively?
Please find below the description for the inputs of YIELD(Settlement, Maturity, Rate, Pr,
Redemption, Frequency).
Settlement The security's settlement date.
Maturity The security's maturity date.
Rate The security's annual coupon rate.
Pr The security's price per $100 face value.
Redemption The security's redemption value per $100 face value.
Frequency The number of coupon payments per year. For annual payments, frequency =
1; for semiannual, frequency = 2; for quarterly, frequency = 4.

Note that Dates should be entered by using the DATE function. For example, use
DATE(2008,5,23) for the 23rd day of May, 2008.
Answer:
a) Here, we are finding the YTM of a semiannual coupon bond. Remaining maturity is 13 years
meaning 26 periods of 6 months. Coupon per period is 5.4%*1000/2. The bond price
equation is:
P = $1,060 = $27*({1 – [1/(1 + R)]26 }/R) + $1,000*1/(1 + R)26.
Since the coupon payments are semiannual, this is the semiannual interest rate. The YTM is
the APR of the bond, so:

YTM = 2*R

b) Given the bond information, the inputs for YIELD function should be
Settlement =DATE(2020,1,1)
Maturity =DATE(2033,1,1)
Rate 5.4%
Pr 106
Redemption 100
Frequency 2

After applying YIELD function in the Excel with above inputs, you will get YTM = 4.78%.
3. How can you estimate a firm’s cost of debt if this firm has no bond being issued?
Answer:
We can identify comparable firms with credit ratings and utilize their bond yields as a
reference for our desired cost of debt. To pinpoint these analogous firms, we need to assess
their business and financial risk characteristics. Business risk entails examining firms in
similar industries, targeting similar markets or regions, and having comparable competitive
strengths. Meanwhile, financial risk involves considering firms with matching financial ratios,
such as FFO/debt and debt/EBITDA.

4. The Dunley Corp. plans to issue 5-year bonds with YTM=4.5%. It believes the bonds will
have a BBB rating. Given the following information:

Assuming an expected 50% loss rate in the event of default during average economic
times. If it were a recession, assuming the bond yield will increase by 20% and the
expected loss rate is 71% at that time.

a. Estimate Dunley’s cost of debt adjusted for default risk during average economic
times.
b. Redo your estimation for recessions.

Answer:
a. During average economic times, the average default rate for BBB rating bonds is
0.5%. Then, Dunley’s actual cost of debt is:
R D= y− prob ( default ) ×loss rate
R D=4.5 %−0.5 % × 50 %=4.25 %
b. During recessions, we can compute Dunley’s actual cost of debt using the average
dedault rate of 3.0% for BBB rating bonds and the expected loss rate of 71%.
'
R D=4.5 % (1+20 %)−3.0 % ×71 %=3.27 %