CHAPTER 6 TUTORIAL QUESTIONS

1- Is the yield to maturity on a bond the same thing as the required return? Is YTM
the same thing as the coupon rate? Suppose today a 10 percent coupon bond
sells at par. Two years from now, the required return on the same bond is 8
percent. What is the coupon rate on the bond now? The YTM?
2- Suppose you buy a 7 percent coupon, 20-year bond today when it's first

issued. If interest rates suddenly rise to 15 percent, what happens to the

value of your bond? Why?
3- Lycan, Inc., has 6 percent coupon bonds on the market that have 9 years
left to maturity. The bonds make annual payments. If the YTM on these
bonds is 8 percent, what is the current bond price?
4- Merton Enterprises has bonds on the market making annual payments,
with 12 years to maturity, and selling for $963. At this price, the bonds
yield 7.5 percent. What must the coupon rate be on Merton's bonds?
5- App Store Co. issued 20-year bonds one year ago at a coupon rate of 6.1
percent. The bonds make semiannual payments. If the YTM on these
bonds is 5.3 percent, what is the current bond price?
6- Volbeat Corporation has bonds on the market with 10.5 years to maturity,
a YTM of 8.4 percent, and a current price of $945. The bonds make
semiannual payments. What must the coupon rate be on the bonds?
7- If Treasury bills are currently paying 4.1 percent and the inflation rate is
1.6 percent, what is the approximate real rate of interest? The exact real
rate?
8- Suppose the real rate is 2.8 percent and the inflation rate is 3.4 percent.
What rate would you expect to see on a Treasury bill?
9- Bond X is a premium bond making annual payments. The bond has a
coupon rate of 9 percent, a YTM of 7 percent, and has 13 years to
maturity. Bond Y is a discount bond making annual payments. This bond
has a coupon rate of 7 percent, a YTM of 9 percent, and also has 13 years
to maturity. What are the prices of these bonds today? If interest rates
remain unchanged, what do you expect the prices of these bonds to be in
one year? In three years? In eight years? In 12 years? In 13 years? What's
going on here? Illustrate your answers by graphing bond prices versus
time to maturity.
10- Bond J has a coupon rate of 4 percent. Bond S has a coupon rate of 14
percent. Both bonds have 10 years to maturity, make semiannual
payments, and have a YTM of 8 percent. If interest rates suddenly rise by
2 percent, what is the percentage price change of these bonds? What if
rates suddenly fall by 2 percent instead? What does this problem tell you
about the interest rate risk of lower-coupon bonds?
ANSWERS
1.

The yield to maturity is the required rate of return on a bond expressed as a nominal annual
interest rate. For noncallable bonds, the yield to maturity and required rate of return are
interchangeable terms. Unlike YTM and required return, the coupon rate is not a return used as
the interest rate in bond cash flow valuation, but is a fixed percentage of par over the life of the
bond used to set the coupon payment amount. For the example given, the coupon rate on the
bond is still 10 percent, and the YTM is 8 percent.

2.

Price and yield move in opposite directions; if interest rates rise, the price of the bond will fall.
This is because the fixed coupon payments determined by the fixed coupon rate are not as
valuable when interest rates risehence, the price of the bond decreases.
NOTE: Most problems do not explicitly list a par value for bonds. Even though a bond can have
any par value, in general, corporate bonds in the United States will have a par value of $1,000.
We will use this par value in all problems unless a different par value is explicitly stated.

3.

The price of any bond is the PV of the interest payment, plus the PV of the par value. Notice this
problem assumes an annual coupon. The price of the bond will be:

P = $60({1 [1/(1 + .08)]9} / .08) + $1,000[1 / (1 + .08)9]

P = $875.06
We would like to introduce shorthand notation here. Rather than write (or type, as the case may be)
the entire equation for the PV of a lump sum, or the PVA equation, it is common to abbreviate
the equations as:
PVIFR,t = 1 / (1 + R)t
which stands for Present Value Interest Factor
PVIFAR,t = ({1 [1/(1 + R)]t } / R)
which stands for Present Value Interest Factor of an Annuity
These abbreviations are shorthand notation for the equations in which the interest rate and the
number of periods are substituted into the equation and solved. We will use this shorthand
notation in the remainder of the solutions key. The bond price equation for this problem would
be:
P = $60(PVIFA8%,9) + $1,000(PVIF8%,9)
P = $875.06
4. Here we need to find the coupon rate of the bond. All we need to do is to set up the bond pricing
equation and solve for the coupon payment as follows:
P = $963 = C(PVIFA7.5%,12) + $1,000(PVIF7.5%,12)
Solving for the coupon payment, we get:
C = $70.22
The coupon payment is the coupon rate times par value. Using this relationship, we get:
Coupon rate = $70.22 / $1,000
Coupon rate = .0702, or 7.02%
5.

To find the price of this bond, we need to realize that the maturity of the bond is 19 years. The
bond was issued one year ago, with 20 years to maturity, so there are 19 years left on the bond.
Also, the coupons are semiannual, so we need to use the semiannual interest rate and the number
of semiannual periods. The price of the bond is:
P = $30.50(PVIFA2.65%,38) + $1,000(PVIF2.65%,38)
P = $1,095.07

6.

Here, we need to find the coupon rate of the bond. All we need to do is to set up the bond pricing
equation and solve for the coupon payment as follows:
P = $945 = C(PVIFA4.2%,21) + $1,000(PVIF4.2%,21)
Solving for the coupon payment, we get:
C = $38.01
Since this is the semiannual payment, the annual coupon payment is:
2 $38.01 = $76.02
And the coupon rate is the coupon payment divided by par value, so:
Coupon rate = $76.02 / $1,000
Coupon rate = .0760, or 7.60%

7.

The approximate relationship between nominal interest rates (R), real interest rates (r), and
inflation (h), is:
R=r+h
Approximate r = .041 .016
Approximate r =.025, or 2.50%
The Fisher equation, which shows the exact relationship between nominal interest rates, real
interest rates, and inflation, is:
(1 + R) = (1 + r)(1 + h)
(1 + .041) = (1 + r)(1 + .016)
Exact r = [(1 + .041) / (1 + .016)] 1
Exact r = .0246, or 2.46%

8.

Here, we are finding the price of annual coupon bonds for various maturity lengths. The bond
price equation is:
P = C(PVIFAR%,t) + $1,000(PVIFR%,t)
X:

Y:

P0
P1
P3
P8
P12
P13
P0
P1
P3
P8
P12
P13

= $90(PVIFA7%,13) + $1,000(PVIF7%,13)
= $90(PVIFA7%,12) + $1,000(PVIF7%,12)
= $90(PVIFA7%,10) + $1,000(PVIF7%,10)
= $90(PVIFA7%,5) + $1,000(PVIF7%,5)
= $90(PVIFA7%,1) + $1,000(PVIF7%,1)
= $70(PVIFA9%,13) + $1,000(PVIF9%,13)
= $70(PVIFA9%,12) + $1,000(PVIF9%,12)
= $70(PVIFA9%,10) + $1,000(PVIF9%,10)
= $70(PVIFA9%,5) + $1,000(PVIF9%,5)
= $70(PVIFA9%,1) + $1,000(PVIF9%,1)

= $1,167.15
= $1,158.85
= $1,140.47
= $1,082.00
= $1,018.69
= $1,000
= $850.26
= $856.79
= $871.65
= $922.21
= $981.65
= $1,000

All else held equal, the premium over par value for a premium bond declines as maturity
approaches, and the discount from par value for a discount bond declines as maturity approaches.

This is called pull to par. In both cases, the largest percentage price changes occur at the
shortest maturity lengths.
Also, notice that the price of each bond when no time is left to maturity is the par value, even
though the purchaser would receive the par value plus the coupon payment immediately. This is
because we calculate the clean price of the bond.

Maturity and Bond Price

$1,300

$1,200

$1,100

Bond Price

Bond X

$1,000

Bond Y

$900

$800

$700
13 12 11 10 9

2 1

Maturity (Years)

17. Initially, at a YTM of 8 percent, the prices of the two bonds are:
PJ

= $20(PVIFA4%,20) + $1,000(PVIF4%,20)

= $728.19

PS

= $70(PVIFA4%,20) + $1,000(PVIF4%,20)

= $1,407.71

If the YTM rises from 8 percent to 10 percent:

PJ

= $20(PVIFA5%,20) + $1,000(PVIF5%,20)

= $626.13

PS

= $70(PVIFA5%,20) + $1,000(PVIF5%,20)

= $1,249.24

The percentage change in price is calculated as:

Percentage change in price = (New price Original price) / Original price

PJ% = ($626.13 728.19) / $728.19

= 0.1402, or 14.02%
PS% = ($1,249.24 1,407.71) / $1,407.71 = 0.1126, or 11.26%
If the YTM declines from 8 percent to 6 percent:
PJ

= $20(PVIFA3%,20) + $1,000(PVIF3%,20)

= $851.23

PS

= $70(PVIFA3%,20) + $1,000(PVIF3%,20)

= $1,595.10

PJ% = ($851.23 728.19) / $728.19

= .1690, or +16.90%

PS% = ($1,595.10 1,407.71) / $1,407.71 = .1331, or +13.31%

All else the same, the lower the coupon rate on a bond, the greater is its price sensitivity to
changes in interest rates.

10. The Fisher equation, which shows the exact relationship between nominal interest rates, real
interest rates, and inflation, is:
(1 + R) = (1 + r)(1 + h)
R = (1 + .028)(1 + .034) 1
R = .0630, or 6.30%