Finance

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5

P24 Build a Model

13

year,

semiannual coupon bond with a par value of

may be called in 5 years at a call price of

. The bond sells for

. (Assume that the bond has just been issued.)

20

2

:

8%

$1,000

$1,100

$1,040

5

Current yield = /

Current yield =

– Hint: Write formula in words.

Cap. Gain/loss yield = – Hint: Cell formulas should refer to Input Section
Cap. Gain/loss yield = (Answer)

This is a nominal rate, not the effective rate. Nominal rates are generally quoted.

8%

$0.00

$0.00 $0.00 $0.00

$0.00 $0.00 $0.00

$0.00 $0.00 $0.00

$0.00 $0.00 $0.00

8% $0.00 $0.00 $0.00

$0.00 $0.00 $0.00

$0.00 $0.00 $0.00

$0.00 $0.00 $0.00

$0.00 $0.00 $0.00

Coupon rate

Spring 1,

20

7/22/12

Chapter 5. Ch 05 P24 Build a Model

Except for charts and answers that must be written, only Excel formulas that use cell references or functions will be accepted for credit.

Numeric answers in cells will not be accepted.

A 20

–

8%

$1,000

$1,040

$1,100

Basic Input Data:

Years to maturity:

Periods per year:

Periods to maturity:

Coupon rate

Par value:

Periodic payment:

Current price

Call price:

Years till callable:

Periods till callable:

a. What is the bond’s yield to maturity?

Periodic YTM =

Annualized Nominal YTM =

Hint:

This is a nominal rate, not the effective rate. Nominal rates are generally quoted.

b. What is the bond’s current yield?

Current yield =

Hint: Write formula in words.

Hint: Cell formulas should refer to Input Section

(Answer)

c. What is the bond’s capital gain or loss yield?

Cap. Gain/loss yield =

Note that this is an economic loss, not a loss for tax purposes.

d. What is the bond’s yield to call?

Here we can again use the Rate function, but with data related to the call.

Peridodic YTC =

Annualized Nominal YTC =

The YTC is lower than the YTM because if the bond is called, the buyer will lose the difference between the call price and the current price in just 4 years, and that loss will offset much of the interest imcome. Note too that the bond is likely to be called and replaced, hence that the YTC will probably be earned.

NOW ANSWER THE FOLLOWING NEW QUESTIONS:

e. How would the price of the bond be affected by changing the going market interest rate? (Hint: Conduct a sensitivity analysis of price to changes in the going market interest rate for the bond. Assume that the bond will be called if and only if the going rate of interest falls below the coupon rate. That is an oversimplification, but assume it anyway for purposes of this problem.)

Nominal market rate, r:

Value of bond if it’s not called:

Value of bond if it’s called:

The bond would not be called unless r

We can use the two valuation formulas to find values under different r’s, in a 2-output data table, and then use an IF

statement to determine which value is appropriate:

Value of Bond If:

Actual value,

Not called

Called

considering

Rate, r

$0.00

call likehood:

0%

2%

4%

6%

10%

12%

14%

16%

f. Now assume the date is 10/25/2010. Assume further that a 12%, 10-year bond was issued on 7/1/2010, pays interest semiannually (January 1 and July 1), and sells for $1,100. Use your spreadsheet to find the bond’s yield.

Refer to this chapter’s Tool Kit for information about how to use Excel’s bond valuation functions. The model finds the price of a bond, but the procedures for finding the yield are similar. Begin by setting up the input data as shown below:

Basic info:

Settlement (today)

Maturity

Current price (% of par)

Redemption (% of par value)

Frequency (for semiannual)

Basis (360 or 365 day year)

Yield to Maturity:

Hint: Use the Yield function. For dates, either refer to cells in Basic Info above, or enter the date in quotes, such as “10/25/2010”.

Sheet2

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