Chapter 7

8493 Words Feb 19th, 2013 34 Pages
CHAPTER 7

THE VALUATION AND CHARACTERISTICS OF BONDS

PROBLEMS

Assume all bonds pay interest semiannually.

Finding the Price of a Bond – Example 7.1 (page 306)
1. The Altoona Company issued a 25-year bond 5 years ago with a face value of $1,000. The bond pays interest semiannually at a 10% annual rate. a. What is the bond's price today if the interest rate on comparable new issues is 12%? b. What is the price today if the interest rate is 8%? c. Explain the results of parts a and b in terms of opportunities available to investors. d. What is the price today if the interest rate is 10%? e. Comment on the answer to part d.

SOLUTION: PB = PMT [PVFAk,n] + FV [PVFk,n] a. n = 20 ( 2 = 40
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b. What would the bonds be selling for if yields had risen to 12%? c. Assume the conditions in part a. Further assume interest rates remain at 6% for the next 8 years. What would happen to the price of the Fix-It bonds over that time?
SOLUTION:
a. PB = PMT[PVFAk,n] + FV[PVFk,n] = PMT[PVFA3,16] + FV[PVF3,16] = $40[12.5611] + $1,000[.6232] = $502.44 + $623.20 = $1125.64

b. = PMT[PVFA6,16] + FV[PVF6,16] PB = $40[10.1059] + $1,000[.3936] = $404.24 + 393.60 = $797.84 c. As the bonds approached maturity, their price would decline to their $1,000 par value.

6. The Mariposa Co. has two bonds outstanding. One was issued 25 years ago at a coupon rate of 9%. The other was issued 5 years ago at a coupon rate of 9%. Both bonds were originally issued with terms of 30 years and face values of $1,000. The going interest rate is 14% today. a. What are the prices of the two bonds at this time? b. Discuss the result of part a. in terms of risk in investing in bonds.

SOLUTION: PB = PMT [PVFAk,n] + FV [PVFk,n]

a. Old: PB = $45 [PVFA7,10] + $1,000 [PVF7,10] = $45 (7.03726) + $1,000 (.5083) = $824.36

New: PB = $45 [PVFA7,50] + $1,000 [PVF7,50] = $45 (13.8007) + $1,000 (.0339) = $654.93

b. The old bond has a shorter remaining life (term,

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