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CONTENTS
PART 2 VALUATION
6 Bond Valuation
6.1 Basics
Problem. A bond has a face value of $1,000, an annual coupon rate of 5.0%, a yield to maturity
of 9.0%, makes 2 (semiannual) coupon payments per year, and 8 periods to maturity (or 4 years
to maturity). What is price of this bond based on the Annual Percentage Rate (APR)
convention? What is price of this bond based on the Effective Annual Rate (EAR) convention?
Solution Strategy.
We will create a switch that can be used to select either the EAR or APR rate convention. The
choice of rate convention will determine the discount rate / period. For a given discount rate /
period, we will calculate the bond price in four equivalent ways. First, we will calculate the bond
price as the present value of the bond’s cash flows. Second, we use a formula for the bond
price. Third, we use Excel’s PV function for a bond price. Fourth, we use Excel’s Analysis ToolPak
Add-In PRICE function, which only works under the APR convention.
FIGURE 6.1 Spreadsheet Model of Bond Valuation - Basics.
How To Build This Spreadsheet Model.
1. Enter The Inputs and Name Them. Enter 0 in cell B4. This will serve as a switch between the
APR and the EAR rate conventions. To highlight which rate convention is in use, enter
=IF($B$4=1,"Effective Annual Rate","Annual Percentage Rate") in cell D1. Enter the other
inputs into the range B5:B9 and then name each one. Put the cursor on cell B5, click on Insert |
Name | Define, enter CR in the Names in Workbook box, and click on OK. Put the cursor on
cell B6 and repeat the process to name it kd. Repeat the process to give the cells B7, B8, and B9
the names NOP, N, and M, respectively.
2. Calculate the Discount Rate / / Period. The Discount Rate / Period depends on the rate
Convention being used as follows:
Discount Rate / Period = (1+Yield To Maturity) ^ (1/( Number of Payments / Year ))-1 under EAR
(Yield To Maturity) /( Number of Payments) / Year under APR.
Enter =IF($B$4=1,((1+kd)^(1/NOP))-1,kd/NOP) in cell B12 and use the process above to give
the cell B12 the name DR.