Bond Problems and Other Time Value of Money Problems Assume semi-annual interest payments when answering the

bond questions. 1. Today is December 15, 2007 and the price on the 6% coupon rate and the Treasury bond maturing on December 15, 2021 is priced at 115.5, and bond prices are always expressed as a percent of par. Calculate the bonds yield (to maturity). 2. Calculate the price of a 7% coupon six-year bond if its yield (to maturity) is 5%. 3. Calculate the price of a 60-day Treasury bill if its discount interest rate is 4%. The par value is $10,000. 4. A 6% coupon rate bond has a price of 105 (par 100). It paid its last coupon interest payment two months ago and will pay its next interest payment in four months. What is the approximate price including accrued interest that someone would pay to buy the bond today? 5. A 7% coupon bond is first callable in three years at 107. Draw a time line indicating the cash flows on this bond if called at 107 in three years, and calculate the yield to call if todays price is 111. 6. You want to invest in a bond to be held in your Roth IRA. There is a corporate bond yielding 5% and a tax-exempt bond yielding 3.75%. Besides the tax status, the maturity, credit risk and other details of these bonds are identical. Two part question: Which bond would be best for the Roth IRA and explain why? If the bonds will be in a taxable account, how would you decide which bond to choose? 7. There is a 6% coupon one-year bond and a 6% coupon 10-year bond that are both selling at par to yield 6%. If both yields rise 1%, what will be the price of the bonds? What does this tell you about the price volatility of short-term versus longer-term bonds? By regulation, a money market mutual fund must have an average maturity of 90 days or less. What does this tell you about the price volatility of money market funds? 8. A couple wants to buy a $200,000 home. If they can attain a 6% 30-year fixed rate conventional mortgage, what will be their monthly payment for P&I (principal and interest)? Their full monthly payment is P&I plus payments for taxes and insurance, but P&I is the largest chunk. If rates rise to 7.5%, what would be their monthly P&I payment? What does this suggest about the impact of interest rates on the amount of housing the couple can afford? 9a. A 12% coupon, 18-year noncallable bond is priced at $126.50 to yield 9%. Its duration is 8.76 years. Estimate its price change based on modified duration alone from a 0.5% increase in interest rates. b. Would the actual price after the 0.5% change in rates be higher or lower than the price predicted by the bonds modified duration? Hint: Think about the bonds convexity, that is, the curvature of the price-yield relationship on a noncallable bond.

10. Using an EXCEL spreadsheet, calculate the duration of a 15-year 4% coupon rate bond if the yield to maturity is 6%. You may assume annual payments, if desired. Print the spreadsheet. Bond & Time Value of Money Problem Answers 1. PMT = $6/2 =$3, m = 14 x 2 = 28, FV = 100, PV = 115 16 = 115.5, i = 2.248 x 2 32

= 4.50% 2. 3. 4. PMT = 7/2 = 3.5, n = 6 x 2 = 12, FV = 100, i = 5/2 = 2.5; PV = $110.26 P = 100 60 (4) = 99.333 or $9,933.33 for $10,000 par 360

You pay Price + Accrued interest Accrued interest 2 ($3) = $1. So P + accrued interest = $105 + $1 = $106 6 1 3.5 (111) 3.5 3.5 2 3.5 3.5 3 110.5 3.5 + 107

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PV = 111, PMT = 3.5, FV = 107, n = 3 x 2 = 6; i = 2.59 x 2 = 5.18% 6.a. b. Corporate bond because returns are tax exempt in Roth IRA Compare pretax return to pretax return or after-tax return to after-tax return. If marginal tax rate is 28% then 5% x .72 = 3.6% after taxes (corp) vs. 3.75% after taxes (tax-exempt) P1yr = $99.05; PMT = 3, FV = 100, i = 7%/2 = 3.5, n = 1 x 2 = 2 P10yr = $92.89; PMT = 3, FV = 100, i = 3.5, n = 10 x 2 = 20 Price sensitivity increases with maturity. So, money market funds have essentially no interest rate risk.

7.

8. PV = $200,000, i = 6%/12 = 0.5% month, n = 30 x 12 = 360 month FV = 0; PMT = $1,199.10 PV = 200,000, i = 7.5/12 = .625, n = 360, FV = 0; PMT = $1,398.4 As interest rates rise, the amount of housing a family can afford decreases.

9.a. b.

Mod D = D/(1 + i/2) = 8.76/1.045 = 8.38 years p - ModD i P = -8.38(.005)(126.50) = -$5.30 A little higher due to positive convexity of noncallable bonds.