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BOND VALUATION Clifford Clark is a recent retiree who is interested in investing some of his savings in corporate bonds. His financial planner has suggested the following bonds: Bond A has a 7% annual coupon, matures in 12 years, and has a $1,000 face value. Bond B has a 9% annual coupon, matures in 12 years, and has a $1,000 face value. Bond C has an 11% annual coupon, matures in 12 years, and has a $1,000 face value. Each bond has a yield to maturity of 9%. a. Before calculating the prices of the bonds, indicate whether each bond is trading at a premium, at a discount, or at par. b. Calculate the price of each of the three bonds. c. Calculate the current yield for each of the three bonds. (Hint: Refer to footnote 6 for the definition of the current yield and to Table 7.1.) d. If the yield to maturity for each bond remains at 9%, what will be the price of each bond 1 year from now? What is the expected capital gains yield for each bond? What is the expected total return for each bond? e. Mr. Clark is considering another bond. Bond D. It has an 8% semiannual coupon and a $1,000 face value (i.e., it pays a $40 coupon every 6 months). Bond D is scheduled to mature in 9 years and has a price of $1,150. It is also callable in 5 years at a call price of $1,040. 1. What is the bond's nominal yield to maturity? 2. What is the bond's nominal yield to call? 3. If Mr. Clark were to purchase this bond, would he be more likely to receive the yield to maturity or yield to call? Explain your answer. f. Explain briefly the difference between price risk and reinvestment risk. Which of the following bonds has the most price risk? Which has the most reinvestment risk? A 1-year bond with a 9% annual coupon A 5-year bond with a 9% annual coupon A 5-year bond with a zero coupon A 10-year bond with a 9% annual coupon A 10-year bond with a zero coupon g. Only do this part if you are using a spreadsheet. Calculate the price of each bond (A, B , and C) at the end of each year until maturity, assuming interest rates remain constant. Create a graph showing die time path of each bond’s value, similar to that shown in Figure 7.2. 1. What is the expected interest yield for each bond in each year? 2. What is the expected capital gains yield for each bond in each year? 3. What is the total return for each bond in each year?

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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250
BuyFind

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250

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Chapter
Section
Chapter 7, Problem 19SP
Textbook Problem

BOND VALUATION Clifford Clark is a recent retiree who is interested in investing some of his savings in corporate bonds. His financial planner has suggested the following bonds:

  • Bond A has a 7% annual coupon, matures in 12 years, and has a $1,000 face value.
  • Bond B has a 9% annual coupon, matures in 12 years, and has a $1,000 face value.
  • Bond C has an 11% annual coupon, matures in 12 years, and has a $1,000 face value.

Each bond has a yield to maturity of 9%.

  1. a. Before calculating the prices of the bonds, indicate whether each bond is trading at a premium, at a discount, or at par.
  2. b. Calculate the price of each of the three bonds.
  3. c. Calculate the current yield for each of the three bonds. (Hint: Refer to footnote 6 for the definition of the current yield and to Table 7.1.)
  4. d. If the yield to maturity for each bond remains at 9%, what will be the price of each bond 1 year from now? What is the expected capital gains yield for each bond? What is the expected total return for each bond?
  5. e. Mr. Clark is considering another bond. Bond D. It has an 8% semiannual coupon and a $1,000 face value (i.e., it pays a $40 coupon every 6 months). Bond D is scheduled to mature in 9 years and has a price of $1,150. It is also callable in 5 years at a call price of $1,040.
    1. 1. What is the bond's nominal yield to maturity?
    2. 2. What is the bond's nominal yield to call?
    3. 3. If Mr. Clark were to purchase this bond, would he be more likely to receive the yield to maturity or yield to call? Explain your answer.
  6. f. Explain briefly the difference between price risk and reinvestment risk. Which of the following bonds has the most price risk? Which has the most reinvestment risk?
  • A 1-year bond with a 9% annual coupon
  • A 5-year bond with a 9% annual coupon
  • A 5-year bond with a zero coupon
  • A 10-year bond with a 9% annual coupon
  • A 10-year bond with a zero coupon
  1. g. Only do this part if you are using a spreadsheet. Calculate the price of each bond (A, B, and C) at the end of each year until maturity, assuming interest rates remain constant. Create a graph showing die time path of each bond’s value, similar to that shown in Figure 7.2.
    1. 1. What is the expected interest yield for each bond in each year?
    2. 2. What is the expected capital gains yield for each bond in each year?
    3. 3. What is the total return for each bond in each year?

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Chapter 7 Solutions

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Ch. 7 - A sinking fund can be set up in one of two ways:...Ch. 7 - Can the following equation be used to find the...Ch. 7 - The values of outstanding bonds change whenever...Ch. 7 - If interest rates rise after a bond issue, what...Ch. 7 - Discuss the following statement: A bonds yield to...Ch. 7 - If you buy a callable bond and interest rates...Ch. 7 - Assume that you have a short investment horizon...Ch. 7 - Indicate whether each of the following actions...Ch. 7 - Why is a call provision advantageous to a bond...Ch. 7 - Are securities that provide for a sinking fund...Ch. 7 - Whats the difference between a call for sinking...Ch. 7 - Why are convertibles and bonds with warrants...Ch. 7 - Explain whether the following statement is true or...Ch. 7 - Would the yield spread on a corporate bond over a...Ch. 7 - A bonds expected return is sometimes estimated by...Ch. 7 - Which of the following bonds has the most price...Ch. 7 - Which of the bonds has the most reinvestment risk?...Ch. 7 - BOND VALUATION Madsen Motorss bonds have 23 years...Ch. 7 - YIELD TO MATURITY AND FUTURE PRICE A bond has a...Ch. 7 - BOND VALUATION Nesmith Corporations outstanding...Ch. 7 - YIELD TO MATURITY A firms bonds have a maturity of...Ch. 7 - BOND VALUATION An investor has two bonds in his...Ch. 7 - BOND VALUATION An investor has two bonds in her...Ch. 7 - INTEREST RATE SENSITIVITY .An investor purchased...Ch. 7 - YIELD TO CALL Seven years ago the Templeton...Ch. 7 - YIELD TO MATURITY Harrimon Industries bonds have 6...Ch. 7 - CURRENT YIELD, CAPITAL GAINS YIELD, AND YIELD TO...Ch. 7 - BOND YIELDS Last year Carson Industries issued a...Ch. 7 - YIELD TO CALL It is now January 1, 2018, and you...Ch. 7 - PRICE AND YIELD A 7% semiannual coupon bond...Ch. 7 - EXPECTED INTEREST RATE Lourdes Corporations 12%...Ch. 7 - BOND VALUATION Bond X is noncallable and has 20...Ch. 7 - BOND VALUATION You are considering a 10-year,...Ch. 7 - BOND RETURNS Last year Janet purchased a 1,000...Ch. 7 - YIELD TO MATURITY AND YIELD TO CALL Kempton...Ch. 7 - BOND VALUATION Clifford Clark is a recent retiree...Ch. 7 - BOND VALUATION Robert Black and Carol Alvarez are...

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