Question

You own a bond that pays $100 in annual interest, with a $1,000 par value. It matures in 15 years. The market's required yield to maturity on a comparable-risk bond is 12 percent.

a.??Calculate the value of the bond.

b.??How does the value change if the yield to maturity on a? comparable-risk bond? (i) increases to

15

percent or? (ii) decreases to

8

?percent?

c.??Explain the implications of your answers in part b as they relate to? interest-rate risk, premium? bonds, and discount bonds.

d.??Assume that the bond matures in

5

years instead of

15

years and recalculate your answers in parts a and

b.

e.??Explain the implications of your answers in part d as they relate to? interest-rate risk, premium? bonds, and discount bonds.

Answer 1

a). We need to input the following values in the financial calculator:

INPUT	15	12		$100	$1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT			-$863.78

Hence, Value of the Bond = $863.78

b) i). We need to input the following values in the financial calculator:

INPUT	15	15		$100	$1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT			-$707.63

Hence, Value of the Bond = $707.63

b) ii). We need to input the following values in the financial calculator:

INPUT	15	8		$100	$1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT			-$1,171.19

Hence, Value of the Bond = $1,171.19

c). Because of the inverse relationship between the required return and bond price, bond prices will decrease if the required rate of return increases. As long as all other variables remain constant, this will be case. To put in context of the industry, bonds will sell with greater discounts than the face value if the required return increase and at the premium if those required returns decrease.

d).i). We need to input the following values in the financial calculator:

INPUT	5	15		$100	$1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT			-$832.39

Hence, Value of the Bond = $832.39

d)ii). We need to input the following values in the financial calculator:

INPUT	5	8		$100	$1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT			-$1,079.85

Hence, Value of the Bond = $1,079.85

e). You have what is called an interest rate risk when the value of the bond changes due to interest changes. The longer the maturity date, more exposure bonds will get to that interest rate risk. When the maturity date decreased, the bond became more stable and had less fluctuation. Coupled with that, when the required return increased, there was a greater discount off the face value, and vice versa.