CRACKGRADEB@GMAIL.COM WWW.CRACKGRADEB.COM M.NO.

9971687048

Q.3 Consider a two-year Rs. 1000 face value 10% coupon rate bond which pays
coupon semiannually. Find out the intrinsic value or present value of the bond if
the required rate of return is 14% p.a. Compounded semi-annually.
Face Value of the Bond = Rs.1000
Coupon Rate, C = 10 % = 10/2% =5% in case of semiannual coupon payments
Coupon payment P.a. = Face Value of the Bond*Coupon Rate = Rs.1000*5% = Rs 50 p.a.
Maturity Period = 2 yrs = 2*2=4 in case of semiannual coupon payments
M = Rs.1000
Present Value of Bond =PV
i= 14%=0.14/2= 0.07

Bond Price = Coupon PVIFA ( 14 /2 )%, 2x2) + M x PVIF (( k/ 2 )%, 2x2)

Bond Price = 50 * PVIFA (7%, 4) + 1000* PVIF (7%,4)

Bond price = 50*{1 – 1/ (1+0.07)4} / 0.07 + 1000 / (1+ 0.07)4

Bond Price = 932.25

Q.4 A Deep Discount Bond (DDB) was issued by a financial institution for a
maturity period of 10 years and having a par value of Rs. 25,000. Find out the
value of the Bond given that the required rate of return is 16%.
Face Value of the Bond = Rs.25000
Coupon payment zero in case of deep discount bond
Maturity Period = 10 yrs
M = Rs.25000
Present Value of Bond =PV
i= 16%=0.16

Since the bond is a zero coupon bond coupon rate will be zero. C=0

PV = C * PVIFA (16%, 10) + M* PVIF (16%,10)

Bond Price = 0 + 25000* PVIF (16%,10)

Bond price = 0 + 25000 / (1+ 0.16)10

Bond Price = 5667

Q.5 A Rs. 100 perpetual bond is currently selling for Rs. 95. The coupon rate of
interest is 14.5 percent and the appropriate discount rate is 16 percent. Calculate
the value of the bond. Should it be bought? What is its yield at maturity?

Intrinsic/Present Value of Perpetual Bond = Coupon / YTM

Intrinsic/ Present Value of Perpetual Bond = 14.5 / 0.16 = 90.625

Since market value>intrinsic/present value we can conclude that the bond is currently
overpriced. Hence the bond should not be purchased.

YTM = 14.5/ 95 = 15.26%

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Q.6 Consider three pure discount bonds with maturities of one, two and three
years and prices of Rs930.23, Rs923.79 and Rs 919.54 respectively. Each bond has
a face value of Rs1000. What are the 1 year, 2 year and 3 year interest rates?

Solution
For zero coupon bonds, bond price is calculated using following formula
n
Price = FV / (1 + S)
1 year bond 930.23 = 1000 /(1 + S1)1 Solving we get S1 = 7.5%

2 year bond 923.79 = 1000 /(1 + S1)2

Solving we get S2 = 4.04%

3 year bond 919.54 = 1000 /(1 + S1)3

Solving we get S3 = 2.84%

Yield to maturity can be calculated using approximate formula as follows:

Approx . YTM = C + (F − P)/ n
(F + P)/ 2
P = price of the bond or present value
C = coupon payment
F = maturity value
n = years to maturity
Q.7 A bond is issued at 10% discount to its face value of Rs1lakh. Redemption
takes place at the end of 20 years. If the coupon is 12%. what is the YTM as per
approximate method?

P = price of the bond or present value = 0.9*100000 = 90000

C = coupon rate = 12 %
Coupon payment = F. V. of the Bond*Coupon Rate = Rs.100000*12% = Rs 12000 p.a.
F = maturity value = 100000
n = years to maturity = 20
Approx . YTM = 12000 + (100000− 90000)/ 20 = 13.15%
(100000+ 90000)/ 2

Interpolation formula to calculate YTM or Internal rate of return (IRR):

Calculation

Step 1: Select 2 discount rates for the calculation of NPVs

You can start by selecting any 2 discount rates on a random basis that will be used to calculate the net
present values in Step 2.

It is important however not to select discount rates that are ridiculously distant from the IRR/YTM (e.g.
10% and 90%) as it could undermine accuracy.

Although guessing the IRR/YTM before you have calculated it would be kind of hard, try your best to keep
the two discount rates that you select within a reasonable range to improve the accuracy of your
calculation.

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Step 2: Calculate NPVs of the investment using the 2 discount rates

You shall now calculate the net present values of the investment on the basis of each discount rate
selected in Step 1.

Step 3: Calculate the IRR/YTM

Using the 2 discount rates from Step 1 and the 2 net present values derived in Step 2, you shall calculate
the IRR/YTM by applying the IRR/YTM Formula stated above.

YTM = Low % + (PV @ Lower − Actual Desired) x (High % − Low %) YTM or IRR

(PV @ Lower − PV @ Higher)

Q.8 If market price of bond is Rs. 95. Years to maturity is 6 yrs: coupon rate =13
% p.a. and issue price is Rs. 100. Calculate the yield to maturity.

Maturity = 6 Yrs
Present Value = Rs. 95
Coupon = 13%
Interest P.a. = Face Value of the Bond*Coupon Rate = Rs.100*13% = Rs 13 p.a.

We will use interpolation

Calculate PV/price of bond @ YTM of 14%

PV = C*{1 – 1/ (1+i)n} / i + M / (1+ i)n

PV = 13*{1 – 1/ (1+0.14)6} / 0.14 + 100 / (1+ 0.14)6 = 96.11

Calculate PV/price of bond @ YTM of 15%

PV = C*{1 – 1/ (1+i)n} / i + M / (1+ i)n

PV = 13*{1 – 1/ (1+0.15)6} / 0.15 + 100 / (1+ 0.15)6 = 92.43

Using interpolation

YTM = Low % + (PV @ Lower − Actual Desired) x (High % − Low %) YTM or IRR

(PV @ Lower − PV @ Higher)

= 14% + (96.11−95) x 1% = 14.30%

(96.11−92.43)

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Q.9 Arvind recently purchased a bond with Rs1000 face value, coupon 10% and
four years to maturity. The bond makes annual interest payments and the first one
is due one year from now. Arvind paid Rs1032.40 for the bond. What is bond’s
YTM?

Maturity = 4 Yrs
Present Value = Rs. 1032.40
Coupon = 10%
Coupon P.a. = Face Value of the Bond*Coupon Rate = Rs.1000*10% = Rs 100 p.a.

We will use interpolation

Calculate PV/price of bond @ YTM of 14%

PV = C*{1 – 1/ (1+i)n} / i + M / (1+ i)n

PV = 100*{1 – 1/ (1+0.14)4} / 0.14 + 1000 / (1+ 0.14)4 = 1011

Calculate PV/price of bond @ YTM of 12%

PV = C*{1 – 1/ (1+i)n} / i + M / (1+ i)n

100*{1 – 1/ (1+0.12)4} / 0.12 + 1000 / (1+ 0.12)4 = 1045.90

Using interpolation

YTM/IRR = Low % + (PV @ Lower − Actual Desired) x (High% − Low %) YTM or IRR

(PV @ Lower − PV @ Higher)

= 12% + (1045.90−1032.40) x 2% = 12.775%

(1045.90−1011)

Internal rate of return (IRR): Internal rate of return (IRR) is the discount rate at which the net present
value of an investment becomes zero. In other words, IRR is the discount rate which equates the present
value of the future cash flows of an investment with the initial investment.

The following is the formula for calculating NPV:

where:
Ct = net cash inflow during the period t
Co= total initial investment costs

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r = discount rate, and

t = number of time periods
NPV = 0; or PV of future cash flows − Initial Investment = 0; or

CF1 CF2 CF3

+ + + ... − Initial Investment = 0
( 1 + r )1 ( 1 + r )2 ( 1 + r )3
Where,
r is the internal rate of return;
CF1 is the period one net cash inflow;
CF2 is the period two net cash inflow,
CF3 is the period three net cash inflow, and so on ...

To calculate IRR using the formula, one would set NPV equal to zero and solve for the discount rate r,
which is here the IRR. Because of the nature of the formula, however, IRR cannot be calculated
analytically, and must instead be calculated either through trial-and-error or interpolation method as given
above.

Q.10 Mr. Mohan bought bonds of the face value of Rs.1000/- each at a discount of 10% on
face value, bearing coupon@ 10% p.a., residual tenure for redemption at par being exactly 2
years from the date of acquisition. What is the IRR? (RBI SAMPLE QUESTIONS)
(1) 11.11%
(2) 18.12%
(3) 12.12%
(4) 16.18%
(5) 15.25%

Maturity = 2 Yrs
Present Value = 90% of Face Value = Rs. 900
Coupon = 10% Coupon payment= Face Value *Coupon Rate = Rs.1000*10% = Rs 100

Approx . YTM / IRR = 100+ (1000 − 900)/ 2 = 15.78%

(1000+ 900)/ 2

Approx. YTM formula indicates that YTM is closer to 16 %. Now it is difficult to choose one option from
15.25% and 16.18% as given.

We can use hit and trial method and can calculate PV @ 15.25% and 16.18% using this formula:
PV = C*{1 – 1/ (1+i)n} / i + M / (1+ i)n and can select one option otherwise we can use
interpolation formula as given below:

As approx.. YTM is closer to 16 % , now we will calculate PV/price of bond @ YTM of 16%

PV = C*{1 – 1/ (1+i)n} / i + M / (1+ i)n

PV = 100*{1 – 1/ (1+0.16)2} / 0.16 + 1000 / (1+ 0.16)2 = 903.68

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Now Calculate PV/price of bond @ YTM of 18%

PV = C*{1 – 1/ (1+i)n} / i + M / (1+ i)n

PV = 100*{1 – 1/ (1+0.18)2} / 0.18 + 1000 / (1+ 0.18)2 = 874.74

*We have to choose 2 nd

YTM/IRR so that desired PV must lie between PVs calculated at
lower and higher YTM/IRR rates.(900 is desired PV and it lies between calculated PVs
903.68 & 874.74 @ 16% & 18% ).

YTM/IRR = Low % + (PV @ Lower − Actual Desired) x (High% − Low %) YTM or IRR

(PV @ Lower − PV @ Higher)

= 16% + (903.68−874.74) x 2% = 16.18%

(903.68−900)

Hence answer will be 16.18%.

Q.11 Mrs. Laxmi bought 10% p.a. Bonds of ABC Limited for Rs.105/- each, the face
value being Rs.100/- each, with maturity date being exactly 3 years after the date
of acquisition. Assuming market rate of return being 12% p.a., the per bond
present value of the inflow will be:
(1) Rs. 130.00
(2) Rs. 95.30
(3) Rs. 102.70
(4) Rs. 87.90
(5) Rs. 114.40

Solution:
Bond is purchased at Rs 5 Premium @ Rs.105 having face value Rs. 100.
Maturity, n = 3 Yrs
Coupon = 10% Coupon payment= Face Value *Coupon Rate = Rs.100*10% = Rs 10
Face value or maturity value = 100
Market rate of return , i= 12%=0.12

PV = C*{1 – 1/ (1+i)n} / i + M / (1+ i)n

PV = 10*{1 – 1/ (1+0.12)3} / 0.12 + 1000 / (1+ 0.12)3 = 95.30

Hence answer will be Rs. 95.30.

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Numerical:

1. A bond with 7.5% coupon interest – payable half yearly, Face Value 10,000 &
Term to maturity of 2 years is traded in the market. Find the Market Price of the
Bond if the YTM is 10%. (Ans .9559.75).
2. A Rs. 1,000 face value ABC bond has a coupon rate of 6%, with interest paid
semi-annually, and matures in 5 years. If the bond is priced to yield 8%, what is
the bond’s value today? Ans.(918.89).
3. There is a 9%, 5 year bond issue in the market. The issue price is Rs90 and the
redemption price is Rs105. what is yield to maturity. (YTM = 9.4876%).
4. A Rs. 1,000 face value bond has a coupon of 10% (paid semi-annually) matures in
4 years, and has current price of Rs. 1140 what is the EFG bond’s yield to
maturity? (YTM = 6.00%).
5. A Deep Discount Bond was issued by financial institution for a maturity period of
10 years and having a par value of Rs.25000. Find out the value of the Bond if the
required rate of return is 16%.( Ans. 6175).

Miscellaneous numerical:
Newchem Corporation has issued a fully convertible 10% bond of Rs. 10,000 face value,
convertible into 20 equity shares. The current market price of the bond is Rs. 10,800,
whereas, the current market price of equity share price is Rs. 480. You are required to
calculate (i) the conversion premium and ii) the conversion value.

Solution
a) Conversion price = Market Price of Bond / Conversion Rate
Conversion price = 10800 /20 = 540

b) Conversion Premium = (Conversion Price – Current Share Price) / Current Share Price

Conversion Premium = (540 − 480) /480 = 0.125 = 0.125 x 100% =12.5%

c) Conversion Value or Stock Value = Current Market Price x Conversion Ratio = 480*20 = 9600

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