Question

FYI bonds have a par value of $1,000. The bonds pay $40 in interest every six months and will mature in 10 years.

a. Calculate the price if the yield to maturity on the bonds is 7, 8, and 9 percent, respectively.

b. Explain the impact on price if the required rate of return decreases.

c. Compute the coupon rate on the bonds. How does the relationship between the coupon rate and the yield to maturity determine how a bond's price will compare to it par value?

Answer 1

let me know if you need any clarification..

ans a
	we have to use financial calculator to solve this problem
	put in calculator for each individual case
			YTM 7%		YTM 8%		YTM 9%
	FV		1000		1000		1000
	PMT		40		40		40
	N=10*2		20		20		20
	I	=7%/2	3.50%	8%/2	4%	9%/2	4.5%
	Compute PV		($1,071.06)		($1,000.00)		($934.96)
	therfore price =		$1,071.06		$1,000.00		$934.96
ans b	If required rate of return decrease bond price will increase. This is because bond offered coupon
	will proivde return as per coupon rate but discount rate will be lower, therefore causing bond price to increase
Ans c)
	Coupon rate on bond = (40/1000)*2 =				8.00%	Coupon paid semiannual
	There is inverse relation between coupon rate and yield to maturity.
	Coupon rate will not change once bond is issed
	so at the time of issue if coupon rate is higher than YTM bond will be issed at premium
	So relationship is as below - If coupon rate > YTM bond will be traded at premium
	If coupon rate < YTM bond will trade at discount
	If coupon rate = YTM bond will be traded at par