Question

1. Consider a 5-year bond with a current yield of 8% and a coupon rate of 10% (compounded yearly). One year from now this bond will have a quoted price which is most likely:

1. Higher
2. Lower
3. The same
4. Possibly higher or lower

Answer 1

Assume Par Value of Bond = $ 1000

Current Yiled = Coupon maount / Price

8% = $ 100 / Price

Price = $ 100 / 8%

= $ 1250

Yiled from Bond (YTM) = Rate at which PV of Cash Inflows are equal to PV of cash Outflows.

Year	CF	PVF @4%	Disc CF	PVF @5%	Disc CF
0	$ -1,250.00	1.0000	$ -1,250.00	1.0000	$ -1,250.00
1	$     100.00	0.9615	$        96.15	0.9524	$        95.24
2	$     100.00	0.9246	$        92.46	0.9070	$        90.70
3	$     100.00	0.8890	$        88.90	0.8638	$        86.38
4	$     100.00	0.8548	$        85.48	0.8227	$        82.27
5	$ 1,100.00	0.8219	$     904.12	0.7835	$     861.88
NPV	$        17.11		$      -33.53

YTM = Rate at which least +ve NPV + [ NPV at that Rate / Change in NPV due to 1% inc in Rate ] *1%

= 4% + [ 17.11 / 50.64 ] * 1%

= 4% + 0.34 * 1%

= 4% + 0.34%

= 4.34%

Price after 1 Year:

Year	CF	PVF @4.34%	Disc CF
1	$    100.00	0.9584	$      95.84
2	$    100.00	0.9185	$      91.85
3	$    100.00	0.8803	$      88.03
4	$    100.00	0.8437	$      84.37
4	$ 1,000.00	0.8437	$    843.72
Price after 1year	$ 1,203.82

Earlier quoted price is 125%

Now quoted price is 120.38%

Thus Quoted price is lower compared to earlier.