Week 3Time Value of Money and Valuing Bonds
Chapter 6
55.Amortization with Equal Payments Prepare an amortization schedule for a five-year loan of $36,000. The interest rate is 9 percent per year, and the loan calls for equal annual payments. How much interest is paid in the third year? Answer: $2,108.52

56.Amortization with Equal Principal Payments Rework Problem 55 assuming that the loan agreement calls for a principal reduction of $7,200 every year instead of equal annual payments. Answer: $1,944.00

57.Calculating Annuity Values Bilbo Baggins wants to save money to meet three objectives. First, he would like to be able to retire 30 years from now with retirement income of $20,000 per month for 20 years, with the first payment received 30 years and 1 month from now. Second, he would like to purchase a cabin in Rivendell in 10 years at an estimated cost of $325,000. Third, after he passes on at the end of the 20 years of withdrawals, he would like to leave an inheritance of $750,000 to his nephew Frodo. He can afford to save $2,000 per month for the next 10 years. If he can earn an 11 percent EAR before he retires and an 8 percent EAR after he retires, how much will he have to save each month in years 11 through 30? Answer: $2,259.65

58.Calculating Annuity Values After deciding to buy a new car, you can either lease the car or purchase it on a three-year loan. The car you wish to buy costs $28,000. The dealer has a special leasing arrangement where you pay $1 today and $380 per month for the next three years. If you purchase the car, you will pay it off in monthly payments over the next three years at an 8 percent APR. You believe you will be able to sell the car for $15,000 in three years. Should you buy or lease the car? What break-even resale price in three years would make you indifferent between buying and leasing? Answer: Lease, $20,161.86

66.Calculating Annuity Payments This is a classic retirement problem. A time line will help in solving it....

...Bond P is a premium bond with a 12 percent coupon. Bond D is a 6 percent coupon bond currently selling at a discount. Both bonds make annual payments, have a YTM of 9 percent, and have five years to maturity. The current yield for Bonds P and D is percent and percent, respectively. (Do not include the percent signs (%). Round your answers to 2 decimal places. (e.g., 32.16)) |
If interest rates remain unchanged, the expected capital gains yield over the next year for Bonds P and D is percent and percent, respectively. (Do not include the percent signs (%). Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16)) |
Explanation:
To find the capital gains yield and the current yield, we need to find the price of the bond. The current price of Bond P and the price of Bond P in one year is: |
P: | P0 = $120(PVIFA9%,5) + $1,000(PVIF9%,5) = $1,116.69 |
| |
| P1 = $120(PVIFA9%,4) + $1,000(PVIF9%,4) = $1,097.19 |
| |
| Current yield = $120 / $1,116.69 = .1075 or 10.75% |
| |
| The capital gains yield is: |
| |
| Capital gains yield = (New price – Original price) / Original price |
| |
| Capital gains...

...a Treasury note paying an annual coupon of 5.06 percent. The other is a TIPS which pays 3 percent interest annually.
a. If inflation remains constant at 2 percent annually over the next five years, what will be Judy's annual interest income from the TIPS bond? From the Treasury note?
b. How much interest will Judy receive over the five years from the Treasury note? From the TIPS?
c. When each bond matures, what par value will Judy receive from the Treasury note? The TIPS?
d. After five years, what is Judy's total income (interest + par) from each bond? Should she use this total as a way of deciding which bond to purchase?
P4
4. Assume a $1,000 face value bond has a coupon rate of 8.5 percent, pays interest semi-annually, and has an eight-year life. If investors are willing to accept a 10.25 percent rate of return on bonds of similar quality, what is the present value or worth of this bond?
P6
6. The Garcia Company's bonds have a face value of $1,000, will mature in ten years, and carry a coupon rate of 16 percent. Assume interest payments are made semi-annually.
a. Determine the present value of the bond's cash flows if the required rate of return is 16.64 percent.
b. How would your answer change if the required rate of return is 12.36...

...current yield is 10 percent.
Q6 Which of the following is not correct[This question carries 1 mark]
(a)Liquidity in a financial market refers to how easy it is to buy or sell a security in the secondary market when you want to without incurring significant costs.
(b)When money serves as the item in which prices are denoted, money is serving the role of unit of account
(c)Outside money is also known as fiat money
(d) If you withdraw $500 out of your checking account, M1 would increase
(e)Money created in the private sector, such as checking accounts at banks, is inside money
Q7.Why Do Bond Prices Go Up and Down? (Ch 4, pages, and also pages 61-62, 68, 69, and 70)
With bond investing, prices go up and down because of two factors: change in interest rates and changes in quality of credit. Managing interest rate risk has become the most critical variable in the management of bond portfolios.
Chapter 4
Q 8 The following 10 questions are Multiple Choice Question. Mark(Select) the appropriate answer(each carry 1 mark)
(i) The concept of ________ is based on the common-sense notion that a dollar paid to you in the future is less valuable to you than a dollar today.
A) future value
B) present value
C) interest
D) deflation
(ii) The present value of an expected future payment ________ as the interest rate increases.
A) rises
B) falls
C) is constant
D) is unaffected
(iii) If a $5,000...

...BOND PROBLEM SOLUTIONS
1. Six years ago, The Corzine Company sold a 20-year bond issue with a 14 percent annual coupon rate and a 9 percent call premium. Today, Corzine called the bonds. The bonds originally were sold at their face value of $1,000. Compute the realized rate of return for investors who purchased the bonds when they were issued and who surrender them today in exchange for the call price.
PV = 1000; N = 6; PMT = 140; FV = 1090; CPT I/Y
I/Y = 15.02%
2. You just purchased a bond which matures in 5 years. The bond has a face value of $1,000, and has an 8 percent annual coupon. The bond has a current yield of 8.21 percent. What is the bond’s yield to maturity?
CURRENT YIELD = ANNUAL COUPON ( PV
0.0821 = 80 ( PV
PV = 80 ( 0.0821 = 974.42
N = 5; PMT = 80; FV=1000; PV = 974.42 CPT I/Y
I/Y = 8.65%
3. The Dass Company’s bonds have 4 years remaining to maturity. Interest is paid annually; the bonds have a $1,000 par value; and the coupon interest rate is 9 percent. What is the yield to maturity at a current market price of $829? Would you pay $829 for one of these bonds if you thought that the appropriate rate of return was 12 percent?
PV = 829; N = 4; FV = 1000; PMT =90; CPT I/Y...

...and Answers
Using present value to value bonds
A bond, from the perspective of the person issuing the bond is a form of long term debt.
In the hands of the person who has acquired the bond it is an asset.
The agency issuing the bond agrees to pay a fixed sum of money to the holder of the bond for a period of years and then, at the end of that period, to pay back the face value of thebond.
Bonds can be issued by a variety of agencies/companies:
1. Municipal bonds: issued by cities, states and other local agencies
2. Government bonds: issued by the department of finance/treasury department of a government
3. Corporate bonds: issued by companies
Our main interest in relation to bonds is in corporate bonds. Why do companies issue bonds?
• Raise finance
• Often cheaper than bank borrowings
Terminology relevant to bond valuation
• Nominal/Face value/Principal – This is the amount on which interest payments are based. It is normally a round sum such as €1,000.
• Redemption value – This is the amount that will be paid out by the issuer of the bond when he comes to repay/redeem it.
• Coupon – The amount of interest paid on the bond is referred to as the coupon and the rate (%) is the coupon...

...INTRODUCTION
- The Swan Davis Corporation case focuses on following issues:
The importance in bond and stock valuation;
The capital structure of the company; and
How they effects to the capital budgeting decisions of the company.
- Swan- Davis Inc., (SDI) manufactures equipment for sale to large contractors, the company was found in 1976 and it went to the public in 1980 at its shares value risen from $1 to $15 since it enter to the market.
- The financial statements for the past three years show a decline trend in both the operation and return on shareholder of the company, so a closer look at the factors contributing to this decline is needed.
- The capital structure of company mainly constitutes of:
1. Deb
a. Bond A which is activities trade and highly liquid, issued 10 years ago, and it has 10 years to maturity.
b. Bond B which is thinly traded and no valid market quotation is available; it has 23 years to maturity more.
2. Preferred stock
3. Equity Stock and retained earning.
Question 1:
If an investor bought some of SDI's A bonds at the current market price, what would be his/her yield to maturity?
Look at the case concerns, bond A has a $1000 par value and coupon rate is 10%, pail semiannually. The bond was issued 10 years ago, and has 10 years to maturity; current market price is $1092.
Input data Calculation result is compounded semiannually
Par value...

...perpetual bond is currently selling for RS. 95/-. The coupon rate of interest is 13.5%. The approximate discount rate is 15%. The value of the bond and the YTM is:
(a) Rs. 90/- and 14.2% Value is (13.5*15%=90) and YTM is ((13.5/95)*100=14.21%)
(b) Rs. 100/- and 13.5%
(c) Rs. 90 and 15%
(d) Rs. 90/- and 13.5%
902. In 2001, Meridian Ltd. has issued bonds of Rs. 10,000/-each due in 2011 with a 14% per annum coupon rate payable at the end of each year during the life of the bond. If the required rate of interest is 8%, find the present value of the bond. Tick the nearest option.
(a) 10,000
(b) 7302
(c) 2,700
(d) 14,026 (9394.11+4631.93=14026.05)
903. The present market value of an equity share is Rs. 80/-; and the exercisable price of the warrant is Rs. 60/- per share. An investor is holding a warrant entitling him to purchase 50 equity shares. The minimum value of the warrant is:
(a) 1,000/- (80-60=20*50=1000)
(b) 4,000/-
(c) 3,000/-
(d) None of these
904. A bond with a coupon rate of 8% is available at its face value of Rs. 1,000/-. The market rate of return on an instrument with similar risk goes down to 6%. The bond price will become:
(a) 1,000/-
(b) 750/-
(c) 1,333/- (800/6%)
(d) None of these
905. A bond with a coupon rate of 10% is available at Rs. 1,250/-. The face value of the bond is Rs. 1,000/-. The...

...Bonds and Their Valuation
After reading this chapter, students should be able to:
• List the four main classifications of bonds and differentiate among them.
• Identify the key characteristics common to all bonds.
• Calculate the value of a bond with annual or semiannual interest payments.
• Explain why the market value of an outstanding fixed-rate bond will fall when interest rates rise on new bonds of equal risk, or vice versa.
• Calculate the current yield, the yield to maturity, and/or the yield to call on a bond.
• Differentiate between interest rate risk, reinvestment rate risk, and default risk.
• List major types of corporate bonds and distinguish among them.
• Explain the importance of bond ratings and list some of the criteria used to rate bonds.
• Differentiate among the following terms: Insolvent, liquidation, and reorganization.
• Read and understand the information provided on the bond market page of your newspaper
Characteristics of Bonds
A bond is a long-term contract under which a borrower (the issuer) agrees to make payments of interest and principal, on specific dates, to the holders (creditors) of the bond.
Bearer bond - Bonds that are not...

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