Practice Problems on Finance
1. Stiles Corporation issues a new series of bonds on January 1, 1982. The bonds were sold at part ($1000), had a 12% coupon, and matured in 30 years, on December 31, 2011. Coupon payments are made semiannually (on June 30 and December 31).
a) What was the YTM on January 1, 1982? - Explain
b) What was the price of the bonds on January 1, 1987, 5 years later, assuming that interest rates had fallen to 10%? (Show in equation form, plug all the relevant numbers and without calculation, say whether the price would be above or below the par value)
c) Assume price you calculated is $1150. Find the current yield, capital gains yield, and total return on January 1, 1987. Explain what each of the calculated terms indicate.
d) On July 1, 2005, 6.5 years before maturity, Pennington’s bonds sold for &916.42. What was the YTM, the current yield, capital gains yield, and total return at that time? (No need to calculate them, but show in equation form, and conclude whether they increased, decreased or stayed the same and why)
e) Now assume that you plan to purchase an outstanding Pennington bond on March 1, 2005, when the going rate of interest given its risk was 15.5%. How large a check must you write to complete the transaction?
2. A bond’s expected return is sometimes estimated by its YTM and sometimes by its YTC. Under what conditions would the YTM provide a better estimate and when would the YTC be better? EXPLAIN
3. An investor has two bonds in his portfolio that both have a face value of $1000 and pay a 10% annual coupon. Bond L matures in 15 years, while Bond S matures in 1 year.
a) What will the value of each bond be if the going interest rate is 5%, 8%, and 12%? Assume that there is only one more interest payment to be made on Bond S. at its maturity, and 15 more payments on Bond L.
b) Why does the longer-term bond’s price vary more when interest rates change than does that of the shorter-term bond?
4. Last year, Joan purchased a $1000 face value corporate
a) What was the YTM on January 1, 1982? - Explain
b) What was the price of the bonds on January 1, 1987, 5 years later, assuming that interest rates had fallen to 10%? (Show in equation form, plug all the relevant numbers and without calculation, say whether the price would be above or below the par value)
c) Assume price you calculated is $1150. Find the current yield, capital gains yield, and total return on January 1, 1987. Explain what each of the calculated terms indicate.
d) On July 1, 2005, 6.5 years before maturity, Pennington’s bonds sold for &916.42. What was the YTM, the current yield, capital gains yield, and total return at that time? (No need to calculate them, but show in equation form, and conclude whether they increased, decreased or stayed the same and why)
e) Now assume that you plan to purchase an outstanding Pennington bond on March 1, 2005, when the going rate of interest given its risk was 15.5%. How large a check must you write to complete the transaction?
2. A bond’s expected return is sometimes estimated by its YTM and sometimes by its YTC. Under what conditions would the YTM provide a better estimate and when would the YTC be better? EXPLAIN
3. An investor has two bonds in his portfolio that both have a face value of $1000 and pay a 10% annual coupon. Bond L matures in 15 years, while Bond S matures in 1 year.
a) What will the value of each bond be if the going interest rate is 5%, 8%, and 12%? Assume that there is only one more interest payment to be made on Bond S. at its maturity, and 15 more payments on Bond L.
b) Why does the longer-term bond’s price vary more when interest rates change than does that of the shorter-term bond?
4. Last year, Joan purchased a $1000 face value corporate