Chapter 4.

Student Ch04 P24 Build a Model

A 20-year, 8% semiannual coupon bond with a par value of $1,000 may be called in 5 years at a call price of
$1,040. The bond sells for $1,100. (Assume that the bond has just been issued.)

Basic Input Data:

Years to maturity: 20
Periods per year: 2
Periods to maturity: 40
Coupon rate: 8%
Par value: $1,000
Periodic payment: $40
Current price $1,100
Call price: $1,040
Years till callable: 5
Periods till callable: 10

a. What is the bond's yield to maturity?

Peridodic YTM = 3.53%

Annualized Nominal YTM = 7.06% Hint: This is a nominal rate, not the effective rate. Nominal rates are g

b. What is the bond's current yield?

Current yield = YTM Price Hint: Write formula in words.

Current yield = $80 / $1100 Hint: Cell formulas should refer to Input Section
Current yield = 7.27% (Answer)

c. What is the bond's capital gain or loss yield?

Cap. Gain/loss yield = YTM - Current Yield Hint: Write formula in words.
Cap. Gain/loss yield = 7.06% - 7.27% Hint: Cell formulas should refer to Input Section
Cap. Gain/loss yield = -0.21% (Answer)

Note that this is an economic loss, not a loss for tax purposes.

d. What is the bond's yield to call?

Here we can again use the Rate function, but with data related to the call.

Peridodic YTC = 3.16%

Annualized Nominal YTC = 6.33% This is a nominal rate, not the effective rate. Nominal rates are genera

The YTC is lower than the YTM because if the bond is called, the buyer will lose the difference between the call price
and the current price in just 4 years, and that loss will offset much of the interest imcome. Note too that the bond is
likely to be called and replaced, hence that the YTC will probably be earned.
The YTC is lower than the YTM because if the bond is called, the buyer will lose the difference between the call price
and the current price in just 4 years, and that loss will offset much of the interest imcome. Note too that the bond is
likely to be called and replaced, hence that the YTC will probably be earned.

NOW ANSWER THE FOLLOWING NEW QUESTIONS:

e. How would the price of the bond be affected by changing the going market interest rate? (Hint: Conduct a
sensitivity analysis of price to changes in the going market interest rate for the bond. Assume that the bond will
be called if and only if the going rate of interest falls below the coupon rate. That is an oversimplification, but
assume it anyway for purposes of this problem.)

Nominal market rate, r: 8%

Value of bond if it's not called:
Value of bond if it's called: The bond would not be called unless r<coupon.

We can use the two valuation formulas to find values under different r's, in a 2-output data table, and then use an IF
statement to determine which value is appropriate:

Value of Bond If: Actual value,

Not called Called considering
Rate, r $0.00 $0.00 call likehood:
0%
2%
4%
6%
8%
10%
12%
14%
16%

f. Now assume the date is 10/25/2012. Assume further that a 12%, 10-year bond was issued on 7/1/2012, pays
interest semiannually (January 1 and July 1), and sells for $1,100. Use your spreadsheet to find the bond’s
yield.

Refer to this chapter's Tool Kit for information about how to use Excel's bond valuation functions. The model finds the
price of a bond, but the procedures for finding the yield are similar. Begin by setting up the input data as shown below:

Basic info:
Settlement (today)
Maturity Call date
Coupon rate
Current price (% of par)
Redemption (% of par value) Call price
Frequency (for semiannual)
Basis (360 or 365 day year)

Yield to Maturity: Hint: Use the Yield function.For dates, either refer to cells D122 and D123, or enter the d

To find the yield to call, use the YIELD function, but with the call price rather than par value as the
redemption
To find the yield to call, use the YIELD function, but with the call price rather than par value as the
redemption

Yield to call:

You could also use Excel's "Price" function to find the value of a bond between interest payment dates.
 2/1/2012

ears at a call price of

effective rate. Nominal rates are generally quoted.

uld refer to Input Section

uld refer to Input Section

e rate. Nominal rates are generally quoted.

ce between the call price

ote too that the bond is
ce between the call price
ote too that the bond is

rate? (Hint: Conduct a

Assume that the bond will
oversimplification, but

ess r<coupon.

ble, and then use an IF

issued on 7/1/2012, pays

eet to find the bond’s

ons. The model finds the

nput data as shown below:

lls D122 and D123, or enter the date in quotes, such as "10/25/2012".