CHAPTER 7

7-1 Callaghan Motors’ bonds have 10 years remaining to maturity. Interest is paid
annually, the bonds have a $1,000 par value, and the coupon interest rate is 8
BOND VALUATION percent. The bonds have a yield to maturity of 9 percent.

WHAT IS THE CURRENT MARKET PRICE OF THESE BONDS?

0 1 2 3 10
9% ...

80 80 80 80
PV = ? FV = 1,000

INT INT INT M

Bond ' s value  VB    ...  
1  k d  1
1  k d  2
1  k d  N
1  k d  N
N
INT M
 
t 1 1  k d  1  k d  N
t

80 80 80 1000
Bond ' s value  V B    ...  
1  .09 1
1  .09 2
1  .09 10
1  .09 10

10
80 1000
Bond' s value  VB   
t 1  1  .09 t
 1  .09 10

With your financial calculator, enter the following:

N = 10
I = YTM = 9%
PMT = 0.08 x 1,000 = 80
FV = 1000
PV = VB = ?
PV = $935.82.

1
2
3
 7-2 Thatcher Corporation’s bonds will mature in 10 years. The bonds have a face
value of $1,000 and an 8 percent coupon rate, paid semiannually. The price of
YIELD TO the bonds is $1,100. The bonds are callable in 5 years at a call price of $1,050.
MATURITY AND
CALL
What is the yield to maturity? What is the yield to call?

_______________________________________________

(a)
0 1 2 3 20
i=? ...

40 40 40 40
PV= 1,100 FV = 1,000

40 40 40 40 1000
Bond' s value  VB     ...  
1  k d  1
1  k d  2
1  k d  3
1  k d  20
 1  k d  20

20
40 1000
Bond' s value  VB   
t 1 1  k d  t
 1  k d  20

With your financial calculator, enter the following to find YTM:

N = 10 x 2 = 20

PV = -1100

PMT = 0.08/2 x 1,000 = 40

FV = 1,000

I = YTM = ?

YTM = 3.31% x 2 = 6.62%

4
(b)

0 1 2 3 10
i=? ...

40 40 40 40
PV= 1,100 FV = 1,050

N
INT Call Pr ice
Bond' s value  VB   
t 1 1  k d  t
1  k d  N

10
40 1050
Bond' s value  VB   
t 1 1  k d  t
 1  k d  10

With your financial calculator, enter the following to find YTC:

N = 5x2 = 10

PV = -1100

PMT = 0.08/2 x 1,000 = 40

FV = 1050

I = YTC = ?

YTC = 3.24% x 2 = 6.49%

5
 7-3 Nungesser Corporation has issued bonds that have a 9 percent coupon rate,
BOND VALUATION payable semiannually. The bonds mature in 8 years, have a face value of $1,000,
and a yield to maturity of 8.5 percent. What is the price of the bonds?

_______________________________________________

0 1 2 3 16
i=4.25 ...

40 40 40 40
PV= ? FV = 1,000

45 45 45 1000
Bond' s value  VB    
 1  .0425 1
 1  .0425 2
 1  .0425 16
 1  .0425 16

16
45 1000
Bond' s value  VB   
t 1  1  .0425 t
 1  .0425 16

The problem asks you to find the price of a bond, given the following facts:

N = 16

I = 8.5/2 = 4.25

PMT = 45

FV = 1,000

With a financial calculator, solve for PV = $1,028.60

6
 7-4 A bond that matures in 10 years sells for $985. The bond has a face value of
CURRENT YIELD $1,000 and a 7 percent annual coupon.
AND YIELD TO
MATURITY
a. What is the bond’s current yield?
b. What is the bond’s yield to maturity (YTM)?
c. Assume that the yield to maturity remains constant for the next 3 years.
What will be the price of the bond 3 years from today?

____________________________________________

VB = $985

M = $1,000

Int = 0.07 x $1,000 = $70

a. Current yield = annual interest/

current bond price

$70
=
$985.00

= 7.11%

b.

0 1 2 3 10
i=4.25 ...

70 70 70 70
PV= 985 FV = 1,000

7
 70 70 70 1000
Bond' s value  VB    ...  
 1  .k d  1
1  k d  2
kd  10
1  k d  10

10
70 1000
Bond' s value  VB   
t 1 1  k d  t
 1  k d  10

N = 10

PV = -985

PMT = 70

FV = 1,000

YTM = ?

Solve for Y = YTM = 7.2157% ≈ 7.22%

c.

0 1 2 3 15
i=4.25 ...

100 100 100 100

PV= 2 FV = 1,000

N = 7
I = 7.2157
PMT = 70
FV = 1000
PV = ?

Solve for VB = PV = $988.46

8
 7-5 The Garraty Company has two bond issues outstanding. Both bonds pay $100
BOND VALUATION annual interest plus $1,000 at maturity. Bond L has a maturity of 15 years, and
Bond S a maturity of 1 year.
a. What will be the value of each of these bonds when the going rate of interest
is (1) 5 percent, (2) 8 percent, and (3) 12 percent? Assume that there is only
one more interest payment to be made on Bond S.
b. Why does the longer-term (15-year) bond fluctuate more when interest
rates change than does the shorter-term bond (1-year)?

1.(5%)
__________________________________________

0 1 2 15
5% ...
100 100 100

PV=? FV=1,000

100 100 100 1000

Bond' s value  VB    ...  
 1.05 1
 1  .05 2
 .05 15
 1  .05 15

15
100 1000
Bond' s value  VB   
t 1  1  .05 t
 1  .05 15
Bond’s value = VB = $1,518.98

. 5%: Bond L:
Input N = 15

I = 5

PMT = 100

FV = 1000

PV = ?

PV = $1,518.98

9
 5% Bond S

100 1000
Bond' s value  VB  
(1.05) 1 (1.05) 1

Bond’s value = VB = $1,047.62

From Bond L Change N = 1

PV = ?

PV = $1,047.62

2. (8%) 8% Bond L:

100 100 100 1000

Bond' s value  VB    ...  
 1  .08 1
 1  .08 2
 1  .08 15
 1  .05 15

15
100 1000
Bond' s value  VB   
t 1  1  .08 t
 1  .08 15

Bond’s value = VB = $1, 171.19

8% Bond L From Bond S inputs, change N = 15

and I = 8

PV = ?

PV =
$1,171.19

10
 8% Bond S

100 1000
Bond' s value  VB  
(1.08)1 (1.08)1

Bond’s value = VB = $1, 018.52

Bond S: Change N = 1

PV = ?

PV = $1,018.52

3. (12%)

12% Bond L:

100 100 100 1000

Bond' s value  VB    ...  
 1  .12  1
 1  .12 2
 1  .12 15
 1  .12 15

15
100 1000
Bond' s value  VB   
t 1  1  .12 t
 1  .12 15
Bond’s value = VB = $863.78

12% Bond L: From Bond S inputs, change N = 15

and I = 12

PV = ?

PV = $863.78

11
12% Bond S

100 1000
Bond' s value  VB  
(1.012) 1 (1.012) 1

Bond’s value = VB = $982.14

12% Bond S: Change N = 1

PV = ?

PV = $982.14

b. Think bout a bond that matures in one month. Its present value is influenced primarily by
the maturity value, which will be received in only one month. Even if interest rates
double, the price of the bond will still be close to $1,000. A 1-year bond’s value would
fluctuate more than the one-month bond’s value because of the difference of that timing
of receipts. However, its value would still be very close to $1,000 even if the rates
doubled. A long-term bond paying semiannual coupons, on the other hand, will be
dominated by distant receipts, receipts that are multiplied by 1/ (1 + kd/2) t, and if kd
increases, these multipliers will decrease significantly. Another way to view this problem
is from an opportunity point of view. A one-month bond can be reinvested at the new rate
very quickly, and hence the opportunity to invest at this new rate is not lost; however, the
long-term bond locks in subnormal returns for a long period of time.

12
 7-6 The Heymann Company’s bonds have 4 years remaining to maturity. Interest is
YIELD TO paid annually; the bonds have a $1,000 par value; and the coupon interest rate is
MATURITY 9 percent.
a. What is the yield to maturity at a current market price of (1) $829 or (2)
$1,104?
b. Would you pay $829 for one of these bonds if you thought that the
appropriate rate of interest was 12 percent—that is, if k d  12% ? Explain
your answer.

___________________________________________

a.

M = $1,000

I = 0.09 ($1,000) = 90

1. VB = $829:

Input N = 4

PV = -829

PMT = 90

FV = 1000

I = ?

I = 14.99%

2. VB = $1,104:

Change: PV = -1104

I = ?

I = 6.00%

13
b. Yes. At a price of $829, the yield to maturity, 15 percent, is greater than your required
rate of return of 12 percent. If your required rate of return were 12 percent, you should be
willing to buy the bond at any price below $908.88

14
 7-7 Six years ago, The Singleton Company sold a 20-year bond issue with a 14
YIELD TO CALL percent annual coupon rate and a 9 percent call premium. Today, Singleton
called the bonds. The bonds originally were sold at their face value of $1,000.
Compute the realized rate of return for investors who purchased the bonds when
they were issued and who surrender them today in exchange for the call price.

___________________________________________

The rate of return is approximately15.03 percent, found with a calculator using the following
inputs:

N = 6

PV = -1000

PMT = 140

FV = 1090

I = ?

Solve for I = 15.03%

15
 7-8 A 10-year, 12 percent semiannual coupon bond, with a par value of $1,000, may
BOND YIELDS be called in 4 years at a call price of $1,060. The bond sells for $1,100. (Assume
that the bond has just been issued.)

a. What is the bond’s yield to maturity?

b. What is the bond’s current yield?
c. What is the bond’s capital gain or loss yield?
d. What is the bond’s yield to call?

___________________________________________

a. Using a financial calculator, input the following:

N = 20

PV = -1100

PMT = 60

FV = 1000

And solve for I = 5.1849%

However, this is a periodic rate. The nominal annual rate 5.1849% (2) = 10.3699% ≈
10.37%

b. The current yield = $120/$1,100 = 10.91%

16
c. YTM = Current Yield + Capital Gains (Loss) Yield

10.37% = 10.91% + Capital Loss Yield

-0.54% = Capital Loss Yield

d. Using a financial calculator, input the following:

N = 8

PV = -1100

PMT = 60

FV = 1060

And solve for I = 5.0748%

However, this is a periodic rate. The nominal annual rate = 5.0748% (2) = 10.1495% ≈
10.15%

17
 7-9 You just purchased a bond that matures in 5 years. The bond has a face value of
YIELD TO $1,000, an 8 percent annual coupon, and has a current yield of 8.21 percent.
MATURITY What is the bond’s yield to maturity (YTM)?

___________________________________________

The problem asks you to solve for the YTM, given that following facts:

N = 5

PMT = 80

FV = 1000

In order to solve for I we need PV.

However, you are also given that the current yield is equal to 8.21%. Given this information we
can find PV.

Current yield = Annual interest/Current price

0.0821 = $80/PV

PV = $80/0.0821 = $974.42

Now solve for the YTM with a financial calculator:

N = 5

PV = -974.42

PMT = 80

FV = 1000

Solve for I = YTM = 8.65%

18
 7-10 A bond that matures in 7 years sells for $1,020. The bond has a face value of
CURRENT YIELD $1,000 and a yield to maturity of 10.5883 percent. The bond pays coupons
semiannually. What is the bond’s current yield?

___________________________________________

The problem asks you to solve for the current yield, given the following facts:

N = 14

I = 10.5883/2 = 5.29415

PV = -1020

FV = 1000

In order to solve for the current yield we need to find the PMT. With a financial calculator, we
find PMT = $55.00. However, because the bond is a semiannual coupon bond this amount needs
to be multiplied by 2 to obtain the annual interest payment: $55.00 = $110.00. Finally, find the
current yield as follows:

Current yield = Annual interest/Current price = $100/$1,020 = 10.78%

19
 7-11 Lloyd Corporation’s 14 percent coupon rate, semiannual payment, $1,000 par
NOMINAL value bonds, which mature in 30 years, are callable 5 years from now at a price of
INTEREST RATE $1,050. The bonds sell at a price of $1,353.54, and the yield curve is flat.
Assuming that interest rates in the economy are expected to remain at their
current level, what is the best estimate of Lloyd’s nominal interest rate on new
bonds?

___________________________________________

The bond is selling at a large premium, which means that its coupon rate is much higher than the
going rate of interest. Therefore, the bond is likely to be called—it is more likely to be called
than to remain outstanding until it matures. Thus, it will probable provide a return equal to the
YTC rather than the YTM. So, there is no point in calculating the YTM—just calculate the YTC.
Enter these values:

N = 10

PV = -1353.54

PMT = 70

FV = 1050

And then solve for I

The periodic rate is 3.2366 percent, so the nominal YTC is 2 x 3.2366% = 6.4733% ≈ 6.47%.
This would be close to the going rate, and it is about what the firm would have to pay on new
bonds.

20
 7-12 Kaufman Enterprises has bonds outstanding with a $1,000 face value and 10
YIELD TO years left until maturity. The bonds have an 11 percent annual coupon payment.
MATURITY AND The current price of these bonds is $1,175. The bonds may be called in 5 years at
YIELD TO CALL
109 percent of face value (Call price = $1,090).

a. What is the yield to maturity of these bonds?

b. What is the yield to call for these bonds, if called in 5 years?
c. Which yield might investors expect to earn on these bonds, and why?
d. Further inspection of Kaufman Enterprises’ bond indenture reveals that the
call provision on Kaufman’s bonds allows the firm the option to call the
bonds at the end of each year beginning in Year 5. Recall that in Year 5, the
bonds may be called at 109 percent of face value. For each of the next 4
years, the bonds may be called, but each year the call percentage will
decline by 1 percent. Hence, in Year 6 the bonds may be called at 108
percent of face value, in Year 7 the bonds may be called at 107 percent of
face value, etc. If interest rates remain the same, when is the latest that
investors might expect the firm to call the bonds?

___________________________________________

a. To find the YTM:

N = 10

PV = -1175

PMT = 110

FV = 1000

I = YTM = 8.35%

b. To find the YTC, if called in Year 5:

N = 5

PV = -1175

PMT = 110

21
 FV = 1090

I = YTC = 8.13%

c. The bonds are selling at a premium which indicates that interest rates have fallen since the bonds
were originally issued. Assuming that interest rates do not change from the present level,
investors would expect to earn the yield to call. (Note that the YTC is less than the YTM.)

d. Similarly from above, YTC can be found, if called in each subsequent year.

If called in Year 6:

N = 6

PV = -1175

PMT = 110

FV = 1080

I = YTM = 8.27%

If called in Year 7:

N = 7

PV = -1175

PMT = 110

FV = 1070

I = YTM = 8.37%

If called in Year 8:

N = 8

PV = -1175

PMT = 110

FV = 1060

I = YTM = 8.46%

22
If called in Year 9:

N = 9

PV = -1175

PMT = 110

FV = 1050

I = YTM = 8.53%

According to these calculations, the latest investors might expect a call of the bonds is in Year 6.
This is the last year that the expected YTC will be the expected YTM. At this time, the firm still
finds an advantage to calling the bonds, rather than seeing them to maturity.

23
 7-13 A 20-year corporate bond has a par value of $1,000 and a 9 percent annual
BOND VALUATION coupon rate. Assume that your required rate of return is 10 percent and that you
plan to hold on to this bond for 5 years. You, and the market, have expectations
that in 5 years the yield to maturity for this bond (or another bond with similar
risk and maturity) will be 8.5 percent. How much are you willing to pay for this
bond today? [Hint: You will need to know how much you can sell the bond for
at the end of 5 years.]

___________________________________________

First, we must find the amount of money that we can expect to sell this bond for in 5 years. This is found
using the fact that in 5 years, there will be 15 years remaining until the bond matures and that the
expected YTM for this bond at that time will be 8.5%.

N = 15

I = 8.5

PMT = 90

FV = 1000

PV = -$1,041.52

VB = $987.87

We are willing to pay up to $987.87 for this bond today.

24
 7-14 You have just purchased a 10-year, $1,000 par value bond. The coupon rate on
BOND VALUATION this bond is 9 percent and interest is paid semiannually. If you require an
“effective” annual interest rate of 8.16 percent, then how much should you have
paid for this bond?

___________________________________________

Before you can solve for the price, we must find the appropriate semiannual rate at which to evaluate
this bond

EAR = (1 + NOM/2)2 – 1

0.0816 = (1 + NOM/2)2 – 1

NOM = 0.08

Semiannual interest rate = 0.08/2 = 0.04 = 4%

Solving for price:

N = 20

I = 4

PMT = 45

FV = 1000

I = YTM = 9.6911%

25
 7-15 Hooper Printing Inc. has bonds outstanding with 9 years left to maturity. The
CURRENT YIELD bonds have an 8 percent annual coupon rate and, were issued last year at par
AND YIELD TO value of $1,000, but due to changes in interest rates, each bond’s value has fallen
MATURITY
to $901.40. The capital gains yield earned by investors over the last year was—
9.86 percent.

a. What is the expected current yield for the next year?

b. What is the yield to maturity?
c. What is the expected capital gains yield for the next year if interest rates do
not change?

___________________________________________

a. The current yield is defined as the annual coupon payment divided by the current price.

CY = $80/$901.40 = 8.875%

b. Solving for YTM:

N = 9

PV = -901.40

PMT = 80

FV = 1000

I = YTM = 9.6911%

c. Expected capital gains yield can be found as the difference between YTM and the current yield.

26
 CGY = YTM - CY = 9.691% - 8.875% = 0.816%

Alternatively, you can solve for the capital gains yield by first finding the expected price next
year.

N = 8

I = 9.6911

PMT = 80

FV = 1000

PV = -$908.76

VB = $908.76

Hence, the capital gains yield is the present price appreciation over the next year

CGY = (P1 – P0)/P0 = ($908.76 - $ 901.40)/$901.40 = 0.816%

27