CHAPTER 7

INTEREST RATES AND BOND

VALUATION
Solutions to Questions and Problems

4. Here we need to find the YTM of a bond. The equation for the bond price is:

P = ¥104,352 = ¥3,400(PVIFAR%,16) + ¥100,000(PVIFR%,16)

Notice the equation cannot be solved directly for R. Using a spreadsheet, a financial calculator,
or trial and error, we find:

R = YTM = 3.05%

If you are using trial and error to find the YTM of the bond, you might be wondering how to pick
an interest rate to start the process. First, we know the YTM has to be lower than the coupon rate
since the bond is a premium bond. That still leaves a lot of interest rates to check. One way to get
a starting point is to use the following equation, which will give you an approximation of the
YTM:

Approximate YTM = [Annual interest payment + (Price difference from par/Years to maturity)]/
[(Price + Par value)/2]

Solving for this problem, we get:

Approximate YTM = [¥3,400 + (– ¥4,352/16)]/[(¥104,352 + 100,000)/2] = .0306, or 3.06%

This is not the exact YTM, but it is close, and it will give you a place to start.

5. 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 = $962 = C(PVIFA5.70%,8) + $1,000(PVIF5.70%,8)

Solving for the coupon payment, we get:

C = $50.95

The coupon payment is the coupon rate times par value. Using this relationship, we get:

Coupon rate = $50.95/$1,000

Coupon rate = .0510, or 5.10%

6. To find the price of this bond, we need to realize that the maturity of the bond is 14 years. The
bond was issued 1 year ago, with 15 years to maturity, so there are 14 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 = $27(PVIFA3.05%,28) + $1,000(PVIF3.05%,28)
P = $934.73
7. Here we are finding the YTM of a semiannual coupon bond. The bond price equation is:

P = $920 = $28(PVIFAR%,46) + $1,000(PVIFR%,46)

Since we cannot solve the equation directly for R, using a spreadsheet, a financial calculator, or
trial and error, we find:

R = 3.130%

Since the coupon payments are semiannual, this is the semiannual interest rate. The YTM is the
APR of the bond, so:

YTM = 2 × 3.130%
YTM = 6.26%

21. The current yield is:

Current yield = Annual coupon payment/Price

Current yield = $59/$1,063.20
Current yield = .0555, or 5.55%

The bond price equation for this bond is:

P0 = $1,063.20 = $29.50(PVIFAR%,36) + $1,000(PVIFR%,36)

Using a spreadsheet, financial calculator, or trial and error we find:

R = 2.674%

This is the semiannual interest rate, so the YTM is:

YTM = 2  2.674%
YTM = 5.35%

The effective annual yield is the same as the EAR, so using the EAR equation from the previous
chapter:

Effective annual yield = (1 + .02674)2 – 1

Effective annual yield = .0542, or 5.42%

22. The company should set the coupon rate on its new bonds equal to the required return. The
required return can be observed in the market by finding the YTM on the outstanding bonds of
the company. So, the YTM on the bonds currently sold in the market is:

P = $925 = $30(PVIFAR%,40) + $1,000(PVIFR%,40)

Using a spreadsheet, financial calculator, or trial and error we find:

R = 3.343%

This is the semiannual interest rate, so the YTM is:

YTM = 2  3.343%
YTM = 6.69%
25. To find the number of years to maturity for the bond, we need to find the price of the bond. Since
we already have the coupon rate, we can use the bond price equation, and solve for the number
of years to maturity. We are given the current yield of the bond, so we can calculate the price as:

Current yield = .0755 = $80/P0

P0 = $80/.0755 = $1,059.60

Now that we have the price of the bond, the bond price equation is:

P = $1,059.60 = $80[(1 – 1/1.072t)/.072] + $1,000/1.072t

We can solve this equation for t as follows:

$1,059.60(1.072t) = $1,111.11(1.072t) – 1,111.11 + 1,000

111.11 = 51.51(1.072t)

2.1571 = 1.072t

t = ln2.1571/ln1.072 = 11.06

The bond has 11.06 years to maturity.

Calculator Solutions

4.
Enter 16 ±¥104,352 ¥3,400 ¥100,000
N I/Y PV PMT FV
Solve for 3.05%

5.
Enter 8 5.7% ±$962 $1,000
N I/Y PV PMT FV
Solve for $50.95
Coupon rate = $50.95/$1,000 = 5.10%

6.
Enter 28 6.1%/2 ±$54/2 ±$1,000
N I/Y PV PMT FV
Solve for $934.73

7.
Enter 46 ±$920 $56/2 $1,000
N I/Y PV PMT FV
Solve for 3.13%
3.13%  2 = 6.26%
21.
Enter 36 ±$1,063.20 $59/2 $1,000
N I/Y PV PMT FV
Solve for 2.674%
2.674%  2 = 5.35%

Enter 5.35% 2
NOM EFF C/Y
Solve for 5.42%

22. The company should set the coupon rate on its new bonds equal to the required return; the
required return can be observed in the market by finding the YTM on outstanding bonds of the
company.

Enter 40 ±$925 $60/2 $1,000

N I/Y PV PMT FV
Solve for 3.343%
3.343%  2 = 6.69%

25. Current yield = .0755 = $80/P0 ; P0 = $80/.0755 = $1,059.60

Enter 7.2% ±$1,059.60 $80 $1,000

N I/Y PV PMT FV
Solve for 11.06