NICE TO MEET YOU

PhD Business Economics (VUB)

Project Finance Analyst (AG Real Estate)

Post-doc (Vlerick Business School)

Revenue Management Consultant (StepUp Consulting)

Teaching assistent (VUB - 20%)

Contact: wouter.thierie@vub.be

Werkcollege BFI_Intro

19-04-2023 | 1
VALUING BONDS
HANDBOOK
P.46
Chapter 3
THEORY

PV cpn cpn Cpn + Par

cpn cpn (cpn  par )

PV  1
 2
 .... 
(1  r ) (1  r ) (1  r ) t

1 +nominal rate
1 +real rate =
1+inflation rate
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THEORY

• Bond price fluctuations to

make bonds comparable
P
• Coupons and face value
YTM cannot change over the
term of the bond

(Remember: Yield to maturity (YTM) is the total return anticipated

on a bond if the bond is held until it matures.)

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 THEORY

The steel technology group offers investors a gross

"New Bekaert bonds worth buying" return of 2.46 percent.

The steel technology group Bekaert wants to raise a

maximum of 200 million euros with the issue of
bonds with a term of seven years. The gross
coupon is 2.75 percent.

But as often, the bonds are issued at 101.875

percent of the nominal value. This means that
investors now pay 1,018.75 euros and receive
1,000 euros on their due date.

What happens if the yields increase to 2.60% after one year?

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PROBLEM SET
QUESTION 1

A 10-year bond is issued with a face value of $1,000, paying coupons of

$60 a year. If yields to maturity increase shortly after the T-bond is
issued, what happens to the bond’s…
a. Coupon rate?
b. Price?
c. Yield to maturity?

a. Does not change. The coupon rate is set at time of issuance.

b. Price falls. The yield to maturity and the price are inversely related.
c. Yield to maturity rises. Since the price falls, the bond’s yield to maturity
will rise.

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PROBLEM SET
QUESTION 2
a. If interest rates rise, bond prices rise/fall. Answer: fall

b. If the bond YTM is greater than the coupon, the price of the bond is
greater/less than the face value. Answer: less

c. If the price of a bond exceeds the face value, the YTM is greater/less
than the coupon. Answer: less

d. High-coupon bonds sell at a higher/lower price than low-coupon bonds.

Answer: higher

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PROBLEM SET
QUESTION 3

True or false.

If a bond’s coupon rate is higher than its yield to maturity, than the bond will
sell for more than face value.

True. If the coupon rate is higher than the yield to maturity, then the bond’s
price must be greater than its face value.

If a bond’s coupon rate is lower than its yield to maturity, than the bond’s
price will increase over its remaining maturity.

True. If the yield to maturity is greater than the coupon, the price will be
below face value. The price will rise and equal face value at maturity.

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PROBLEM SET
QUESTION 4

A 10-year German government bond has a face value of $100 and a

coupon rate of 5% paid annually. Assume that the interest rate (in dollars)
is equal to 6% per year. What is the bond’s PV?

Year 0 Year 1 Year 2 Year 10

5 5
Final payment
= 100
Coupon = (.05 × $100) = 5

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PROBLEM SET
QUESTION 4
A 10-year German government bond has a face value of $100 and a
coupon rate of 5% paid annually. Assume that the interest rate (in dollars)
is equal to 6% per year. What is the bond’s PV?

PV (bond) = (cpn x PVAF) + (final payment x discount factor)

= 5 x[-

= 5 x 7.360 = $92.64

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PROBLEM SET
QUESTION 4

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PROBLEM SET
QUESTION 5A
A five-year bond with a coupon rate of 8% yields 6%. If this YTM remains
unchanged, what will be its current price? Assume annual coupon payments and a
face value of $100.

Year 0 Year 1 Year 2 Year 5

8%×100=8 8 Final payment = 100

PV (bond) = (cpn x PVAF) + (final payment x discount factor)

PV0 = x[-

= x = $108.42

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PROBLEM SET
QUESTION 5A

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 PROBLEM SET
QUESTION 5B
A five-year bond with a coupon rate of 8% yields 6%. If this YTM remains
unchanged, what will be its price in one year hence? Assume annual
coupon payments and a face value of $100.

Year 0 Year 1 Year 2 Year 5

8%×100=8 8 Final payment = 100

PV (bond) = (cpn x PVAF) + (final payment x discount factor)

PV1 = x [ - = $106.93

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 PROBLEM SET
QUESTION 5C

What is the total return to an investor who held the bond over this year?
Year 0 Year 1 Year 2 Year 5

Coupon Cpn1=8 8 Final payment = 100

PV bond P0 = 108.42 P1 = 106.93

If bond’s YTM remains unchanged

=> return = 6% = YTM

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PROBLEM SET
QUESTION 6A
a.) A six-year government bond makes annual coupon payments of 5%
and offers a yield of 3% annually compounded. Suppose that one year
later the bond still yields 3%. What return has the bondholder earned over
the 12-month period?

Year 0 Year 1 Year 2 Year 6

P0=? P1=? Final payment=1,000

Cpn1=?

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PROBLEM SET
QUESTION 6A

Cpn1 = 5%×1,000 = $50

P0 = cpn x PVAF + face value x discount factor

= $50 x [ -

= $1,108.34

P1 = cpn x PVAF + face value x discount factor

= $50 x [ -

= $1,091.59
If bond’s YTM remains unchanged
=> return = 3% = YTM

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PROBLEM SET
QUESTION 6B
b.) A six-year government bond makes annual coupon payments of 5%
and offers a yield of 3% annually compounded. Suppose that the bond
yields 2% at the end of the year. What return did the bondholder earn in
this case?

Year 0 Year 1 Year 2 Year 6

P0=? P1=? Final payment=1,000

Cpn1=?

Bond Bond
yields 3% yields
2%

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PROBLEM SET
QUESTION 6B

Cpn1 = 5%×1,000 = $50

P0 = cpn x PVAF + face value x discount factor

= $50 x [ -

= $1,108.34

P1 = cpn x PVAF + face value x discount factor

= $50 x [ -

= $ 1,141.40
If bond’s YTM changes
=> return differs from YTM

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PROBLEM SET
QUESTION 6

• If a bond’s YTM constant: investor’s return = YTM

• If a bond’s YTM goes down: investor’s return goes up

• If a bond’s YTM goes up: investor’s return goes down

(𝐶𝐹 ¿ ¿ 1+ 𝑃 1) − 𝑃 0
return= ¿
𝑃0

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PROBLEM SET
QUESTION 7

• The nominal interest rate is 10% and the expected annual inflation rate
is 5%. What is the expected real interest rate?

r = - 1 = .0476, or 4.76%

• Given the real interest rate found above, what is the nominal rate if the
expected annual inflation rate rises to 7%?

The nominal rate increases to… 1.0476 × 1.07 – 1 = .1210, or 12.10%

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PROBLEM SET
QUESTION 8

Suppose that you buy a two-year 8% bond at its face value. Inflation is
3% in the first year and 5% in the second. What is your total nominal
return over these two years? What is your real 2-year return?

Nominal 2-year return: – 1 = .1664, or 16.64%

Real 2-year return: r = x – 1 = .0785, or 7.85%

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 PROBLEM SET
QUESTION 9
A bond’s credit rating provides a guide to its price: Aaa bonds yield
3.4% and Baa bonds yield 4.4%. If some bad news causes a 10%
five-year bond to be unexpectedly downrated from Aaa to Baa, what
would be the effect on the bond price? (Assume annual coupons and
a face value of 1,000)

PVbefore downgrade = (cpn x PVAF) + (final payment x discount factor)

= (100) x [ -

= $1,298.84

PVafter downgrade = (100) x [ -

= $1,246.53
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