Lahore School of Economics Financial Management I Bonds and Their Valuation - 2
Lahore School of Economics Financial Management I Bonds and Their Valuation - 2
Lahore School of Economics Financial Management I Bonds and Their Valuation - 2
Financial Management I
Chapter 7
Bonds and their Valuation – 2
Class Examples
Q1) Finding the nominal rate of interest, EFF = 8.16% => APR = 8%
Semiannual interest rate = 0.08/2 = 0.04 = 4%.
Solving for price:
N = 2 10 = 20, I = 4, PMT = 0.09/2 1,000 = 45, FV = 1000; PV = VB = -$1,067.95.
For YTC:
N = 5; PV = -1275; PMT = 120; FV = 1120; I = YTC = 7.31%.
Since the YTC is less than the YTM, or coupon rate is higher than YTM, investors would expect the bonds to be
called and to earn the YTC.
Expected Capital Gains Yield = YTM – Current Yield = 10.91% – 10.14% = 0.77%.
b. The current yield = $120/$1,100 = 10.91%. The current yield will remain the same; however, if the bond is
called the YTC reflects the total return (rather than the YTM) so the capital gains yield will be different.
Q1) N = 10 2 = 20; PV = -1100; PMT = 0.08/2 1,000 = 40; FV = 1000; I = YTM = 3.31% 2 = 6.62%.
N = 5 2 = 10; PV = -1100; PMT = 0.08/2 1,000 = 40; FV = 1050; I = YTC = 3.24% 2 = 6.49%.
b. Knowledgeable investors would expect the return to be closer to 6.1% than to 8%. If interest rates remain
substantially lower than 9.5%, the company can be expected to call the issue at the call date and to refund it with an issue
having a coupon rate lower than 9.5%.
Q5) a. As the bonds were sold at par, the YTM was equal to the coupon rate of 12%.
Expected Capital Gains Yield = YTM – Current Yield = 10% – 10.15% = -0.15%.
Expected Capital Gains Yield = YTM – Current Yield = 14% – 13.09% = 0.91%.