Chapter

Interest Rates and Bond

Valuation

McGraw-Hill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All

Chapter 7 Index of Sample

Problems

Slide # 02 - 03
Slide # 04 - 06
Slide # 07 - 08
Slide # 09 - 10
Slide # 11 - 13
Slide # 14 - 15
Slide # 16 - 22
Slide # 23 - 29
Slide # 30 - 31
Slide # 32 - 33
Slide # 34 - 37
Slide # 38 - 39
Slide # 40 - 43

Coupon payment
Bond price
Time to maturity
Yield to maturity
Current yield
Holding period yield
Interest rate risk
Zero coupon bond
Corporate bond quote
Clean vs. dirty price
Treasury bond quote
Tax equivalent yield
Fisher effect

Bond value
Bond value= present value of coupons +
present value of principal
Yield to maturity (YTM): Interest rate to
making market bond price
Discount bond: face value > bond value
(market value)
premium bond: face value < bond value

2: Coupon payment
A bond has a 7% coupon and pays interest semi-annually.

What is the amount of each interest payment if the face value of a

bond is $1,000?

3: Coupon payment

Coupon rate Face amount

Number of interest payments per year
.07 $1,000

2
$70

2
$35

Interest payment

4: Bond price
A bond has a 9% coupon rate, matures in 12 years and pays
interest semi-annually. The face value is $1,000.

What is the current price of this bond if the market rate of return is
8.3%?

5: Bond price

PV

1 1 /(1 r ) t
C
r

F
(1 r ) t

.083 122
1 1 /(1
)
.09 $1,000
2

.083
2
2

($45 15.015477) $376.8577

$675.6965 $376.8577
$1,052.55

$1,000
.083 122
(1
)
2

6: Bond price

Enter
Solve for

122
N

8.3/2
I/Y

PV
1,052.55

90/2
PMT

1,000
FV

7: Time to maturity
A bond is currently selling at a price of $977.03. The face value is
$1,000 and the coupon rate is 8%. Interest is paid semi-annually.

How many years is it until this bond matures if the market rate of
return is 8.4%?

8: Time to maturity

Enter
Solve for

N
16

8.4/2
I/Y

977.03
PV

80/2
PMT

1,000
FV

There are 16 semi-annual periods, or 8 years, until the bond

maturity date.

9: Yield to maturity
A 6% bond pays interest annually and matures in 14 years. The
face value is $1,000 and the current market price is $896.30.

What is the yield to maturity?

10: Yield to maturity

Enter
Solve for

14
N

I/Y
7.2

896.30
PV

60
PMT

1,000
FV

11: Current yield

An 8%, semi-annual coupon bond has a $1,000 face value and
matures in 8 years.

What is the current yield on this bond if the yield to maturity is

7.8%?

12: Current yield

PV

1 1 /(1 r ) t
C
r

F
(1 r ) t

.078 82

1 1 /(1
)
.08 $1,000
2

.078
2
2

($40 11.73873) $542.18967

$469.54920 $542.18967
$1,011.74

Annual interest
Current price
.08 $1,000

$1,011.74
$80

$1,011.74
.07907

Current yield

$1,000
.078 82
(1
)
2

7.91%

13: Current yield

Enter

82
N

7.8/2
I/Y

Solve for

PV
1,011.74

80/2
PMT

Annual interest
Current price
$80

$1,011.74
.07907
7.91%

Current yield

1,000
FV

14: Holding period yield

You bought a bond exactly one year ago for $1,004.50. Today, you
sold the bond at a price of $987.40. The bond paid interest semiannually at a coupon rate of 6%.

What is your holding period yield on this bond?

15: Holding period yield

Enter
Solve for

12
N

/2
I/Y
4.29

1,004.50
PV

60/2
PMT

987.40
FV

Interest rate risk

The risk to bearing the fluctuation of interest
rate
increase Time to maturity
Decrease Coupon rate

16: Interest rate risk

You own two bonds. Both bonds have a 6% coupon and pay
interest semi-annually. Both have a face value of $1,000. Bond A
matures in two years while bond B matures in 10 years.

What is the price of each bond at a market rate of 6%? What

happens if the rate increases to 7%.

17: Interest rate risk

Bond A:
Enter

22
N

6/2
I/Y

102
N

6/2
I/Y

PV

Solve for
Bond B:
Enter
Solve for

PV
1,000

60/2
PMT
1,000

1,000
FV

60/2
PMT

1,000
FV

18: Interest rate risk

Bond A:
Enter

22
N

7/2
I/Y

60/2
PV
PMT
981.63

1,000
FV

102
N

7/2
I/Y

60/2
PMT

1,000
FV

Solve for
Bond B:
Enter
Solve for

PV
928.94

19: Interest rate risk

You own two bonds. Both bonds mature in 5 years, have a $1,000
face value and pay interest annually. Bond X has an 8% coupon
rate while bond Y has a 3% coupon rate.

What is the price of each bond if the market rate of return is 7%?
What happens to the price of each bond if the market rate falls to
6%?

20: Interest rate risk

Bond X:
Enter

5
N

7
I/Y

5
N

7
I/Y

Solve for
Bond Y:
Enter
Solve for

PV
1,041.00

PV
835.99

80
PMT

1,000
FV

30
PMT

1,000
FV

21: Interest rate risk

Bond X:
Enter

5
N

6
I/Y

5
N

6
I/Y

Solve for
Bond Y:
Enter
Solve for

PV
1,084.25

PV
873.63

80
PMT

1,000
FV

30
PMT

1,000
FV

22: Interest rate risk

Market

Rate
7%
6%

Bond X
8% coupon

Bond Y
3% coupon

$1,041.00
$1,084.25

$835.99
$873.63

4.2%

4.5%

% change
$1,084.25 $1,041.00
4.2%
$1,041.00

$873.63 $835.99
4.5%
$835.99

23: Zero coupon bond

You are considering purchasing a 10-year, zero coupon bond with
a face value of $1,000.

How much are you willing to pay for this bond if you want to earn a
12% rate of return? Assume annual compounding.

24: Zero coupon bond

F
PV
(1 r ) t
$1,000

(1 .12)10
$321.97

25: Zero coupon bond

Enter
Solve for

10
N

12
I/Y

1,000
PV
321.97

PMT

FV

26: Zero coupon bond

Winslow, Inc. issues 20-year zero coupon bonds at a price of
$224.73. The face value is $1,000.

What is the amount of the implicit interest for the first year of this
bonds life?

27: Zero coupon bond

F
(1 r ) t
$1,000
$224.73
(1 r ) 20
$1,000
20
(1 r )
$224.73
PV

(1 r ) 20 4.44978
1 r 4.44978.05
1 r 1.0775
r .0775
r 7.75%

28: Zero coupon bond

F
(1 r ) t
$1,000

(1 .0775)19
$242.14

PV

F
PV
(1 r ) t
$1,000

(1 .0775) 20
$224.73

Implicit interest $242.14 - $224.73

$17.41

29: Zero coupon bond

Enter

19
N

Solve for
Enter
Solve for

20
N

I/Y
7.75
7.75
I/Y

242.14
PV

PV
224.73

PMT

1,000
FV

PMT

1,000
FV

Implicit interest = $242.14 - $224.73 = $17.41

30: Corporate bond quote

The closing price of a bond is quoted in the newspaper as 101.366.

What is the market price if the face value is $1,000?

31: Corporate bond quote

Bond price 101.366% of $1,000

1.01366 $1,000
$1,013.66

32: Clean vs. dirty price

Today, you purchased a bond for $1,065. The bond has an 8%
coupon rate, a $1,000 face value and pays interest semi-annually.
The next payment date is one month from today.

What is the clean price of this bond?

33: Clean vs. dirty price

Clean price Dirty price - Accrued interest

5 .08 $1,000
$1,065 -

2

6
$1,065 - $33.33
$1,031.67

34: Treasury bond quote

The price of a Treasury bond as quoted in the newspaper is 98:28.

How much will you have to pay to purchase a $100,000 bond?

35: Treasury bond quote

28
Bond price 98 % of $100,000
32
98.875% of $100,000
.98875 $100,000
$98,875

36: Treasury bond quote

A Treasury bond has a bid quote of 105:25 and an asked quote of
105:26.

How much will the dealer earn by buying and then selling a
$100,000 Treasury bond?

37: Treasury bond quote

Spread 105 : 26 105 : 25

0 : 01

Spread in dollars 1/32 of 1% of $100,000

.0003125 $100,000
$31.25

38: Tax equivalent yield

You are trying to decide whether you prefer a corporate bond with
a 7% coupon or a municipal bond with a 5% coupon. Since all the
other aspects of the bonds are equivalent as far as you are
concerned, only the annual income is a decision factor.

Which bond should you select if you are in the 25% tax bracket?

39: Tax equivalent yield

After tax yield .07 (1 - .25)
.0525
5.25%
The corporate bond pays 5.25% on an after-tax basis.
The municipal bond pays 5% after taxes.
You should select the corporate bond.

40: Fisher effect

Last year, you earned 14.59% on your investments. The inflation
rate was 4.30% for the year.

What was your real rate of return for the year?

41: Fisher effect

(1 R ) (1 r ) (1 h )
(1 .1459) (1 r ) (1 .043)
1.1459
1 r
1.043
r .0986577
r 9.87%

42: Fisher effect

You are considering investing $10,000 for one year. You would like
to earn 9%, after inflation, on this investment. You expect inflation
to average 3.25% over the coming year.

What nominal rate of return do you want to earn on your

investment?

43: Fisher effect

(1 R ) (1 r ) (1 h )
1 R (1 .09) (1 .0325)
1 R 1.125425
R .125425
R 12.54%

Chapter

End of Chapter 7

McGraw-Hill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All