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    Problem Set 4 FIN 7000

    Uploaded by

    Ripudaman Singh
    This document contains 4 problems related to calculating bond prices and yields. Problem 1 calculates the internal rates of return for 4 investments with different cash flow timings. The 4th investment has the highest IRR of 164% because it receives the largest cash flow earliest. Problem 2 calculates the prices of a 10-year bond paying 5% semiannual coupons under different yield scenarios. Problem 3 does the same calculations for an identical bond but with annual coupons instead of semiannual. Problem 4 determines the yield to maturity of a 10-year zero coupon bond given its price, and calculates the holding period yield if it was held and sold after 5 years.

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    Problem Set 4 FIN 7000

    Uploaded by

    Ripudaman Singh
    67 views3 pages
    This document contains 4 problems related to calculating bond prices and yields. Problem 1 calculates the internal rates of return for 4 investments with different cash flow timings. The 4th investment has the highest IRR of 164% because it receives the largest cash flow earliest. Problem 2 calculates the prices of a 10-year bond paying 5% semiannual coupons under different yield scenarios. Problem 3 does the same calculations for an identical bond but with annual coupons instead of semiannual. Problem 4 determines the yield to maturity of a 10-year zero coupon bond given its price, and calculates the holding period yield if it was held and sold after 5 years.

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    This document contains 4 problems related to calculating bond prices and yields. Problem 1 calculates the internal rates of return for 4 investments with different cash flow timings. The 4th investment has the highest IRR of 164% because it receives the largest cash flow earliest. Problem 2 calculates the prices of a 10-year bond paying 5% semiannual coupons under different yield scenarios. Problem 3 does the same calculations for an identical bond but with annual coupons instead of semiannual. Problem 4 determines the yield to maturity of a 10-year zero coupon bond given its price, and calculates the holding period yield if it was held and sold after 5 years.

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    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    67 views3 pages

    Problem Set 4 FIN 7000

    Uploaded by

    Ripudaman Singh
    This document contains 4 problems related to calculating bond prices and yields. Problem 1 calculates the internal rates of return for 4 investments with different cash flow timings. The 4th investment has the highest IRR of 164% because it receives the largest cash flow earliest. Problem 2 calculates the prices of a 10-year bond paying 5% semiannual coupons under different yield scenarios. Problem 3 does the same calculations for an identical bond but with annual coupons instead of semiannual. Problem 4 determines the yield to maturity of a 10-year zero coupon bond given its price, and calculates the holding period yield if it was held and sold after 5 years.

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    © All Rights Reserved
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    of 3

    Problem Set 4 FIN 7000

    Problem 1: Calculate the annual internal rates of return (IRR) for the following
    investments (time t is in years):
    a. At t = 0, the cost is $100. The cash flows are $100 at t = 1 and $250
    at t = 3.
    Solution: 100 = 100/ (1+r) + 250/ (1+r) 3
    r=0.78
    The IRR is 78%
    b. At t = 0, the cost is $150. The cash flows are $100 at t = 1 and $250
    at t = 3.
    Solution: 150 = 100/(1+r) + 250/(1+r) 3
    r=0.45
    The IRR is 45%
    c. At t = 0, the cost is $100. The cash flows are $100 at t = 1 and $250
    at t = 2.
    Solution: 100 = 100/(1+r) + 250/(1+r) 2
    r = 1.158
    The IRR is 115.8%
    d. At t = 0, the cost is $100. The cash flows are $250 at t = 1 and $100
    at t = 3.
    Solution: 100 = 250/(1+r) + 100/(1+r) 3
    r=1.64
    The IRR is 164%
    Which of these investments has the highest IRR? Why?
    The fourth one has the highest IRR. This is because the fact we get paid more at the
    earliest time.
    Problem 2: Consider a 10-year bond that pays a 5 percent coupon semiannually with a face value of $1000.
    Since the coupon rate is 5 percent semi-annually hence the Bond pays $25 every
    six months.
    a. What is the price of this bond if the annualized yield to maturity of 4
    percent (i.e., the stated rate is .04 compounded semi-annually)?
    Solution: T = 20; C=25; r=0.04/2 =0.02; FV=1000
    Using the Formula as below:
    PV= (C/r) [1-(1/ (1+r) T)] + [F/ (1+R) T]
    PV = $1081.75
    b. What is the price of this bond if the annualized yield to maturity of 5
    percent (i.e., the stated rate is .05 compounded semi-annually)?
    Solution: T = 20; C=25; r=0.05/2 =0.025; FV=1000
    Using the Formula as below:
    PV= (C/r) [1-(1/ (1+r) T)] + [F/ (1+R) T]

    PV = $1000
    c. What is the price of this bond if the annualized yield to maturity of 6
    percent (i.e., the stated rate is .06 compounded semi-annually)?
    Solution: T = 20; C=25; r=0.06/2 =0.03; FV=1000
    Using the Formula as below:
    PV= (C/r) [1-(1/ (1+r) T)] + [F/ (1+R) T]
    PV = $925.613
    d. What is the price of this bond if the annualized effective rate is 5
    percent?
    Solution: rs=m [(1+re)1/m -1] = 0.0489 or 4.89%
    T = 20; C=25; r=0.0489/2 =0.0245; FV=1000
    Using the Formula as below:
    PV= (C/r) [1-(1/ (1+r) T)] + [F/ (1+R) T]
    PV = $1007.831
    Problem 3: Consider the bond described in Problem 2 above but let the coupon be
    paid annually. Answer questions a through c in Problem 2 above for this annual
    coupon paying bond.
    Solution: if the amount is paid annually then coupon rate is $50.
    a. T = 10; C=50; r=0.04; FV=1000
    PV = $1081.11
    b. T = 10; C=50; r=0.05; FV=1000
    PV=$1000
    c. T = 10; C=50; r=0.06; FV=1000
    PV=$926.40
    Problem 4: The price of a 10-year zero-coupon bond is $670 per $1000 in
    face value.
    a. What is its yield to maturity on this bond?
    Using the formula FV=PV (1+r) T
    1000=670(1+r) 10
    r= 0.0408 or 4.08%
    If you buy this 10-year bond today (at t = 0) for $670, hold it for 5
    years, and sell it then (when it is a 5-year zero) for $850, what is your
    holding period yield? If this happens, will the yield to maturity when
    you sell this bond be higher or lower than its current yield to maturity?
    Using the formula FV=PV (1+r) T
    850=670(1+r) 5
    r= 0.0487 or 4.87%
    Hence it is higher than current yield to maturity price.
    b. What price would this bond current 10-year zero have to sell for in 5
    years for the holding period yield to be its current yield to maturity?
    Using the formula FV=PV (1+r) T
    FV= 670(1+.0408) 5 = $818.30

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