Chapter (6) BONDS - Assignment Answers Presented By- Roll-63-Mg Tin Htun Aung

1. How is a bond like a loan?

The solution is to raise money by issuing bonds (or other debt instruments) to a public market.
Thousands of investors then each lend a portion of the capital needed. Really, a bond is nothing
more than a loan for which you are the lender. The organization that sells a bond is known as the
issuer.

2. How does an investor receive a return from buying a bond?

With most bonds, you'll get regular interest payments while you hold the bond. Most bonds
have a fixed interest rate that doesn't change. Some have floating rates that go up or down over
time. On the bond's maturity date, you'll get back the face value.

3. How is yield to maturity related to the concept of rate of return?

The yield to maturity of a bond is the interest rate that equates the price of the bond with the cash
flows you receive from that bond -- the rate you are getting if you assume that "what you get
back" is equal to "what you put in" when you bought the bond. That also happens to be the exact
definition of the internal rate of return of an investment. YTM, therefore, is simply another term
for the IRR of a bond.

4. Does a bonds yield to maturity determine its price or does the price determine the yield
to maturity?

A bond's market price depends on its yield to maturity (YTM). When a bond has a YTM
greater than its coupon rate, it sells at a discount from its face value. When the YTM is equal to
the coupon rate, the market price equals the face value.

5. Explain why the yield of a bond that trades at a discount exceeds the bonds coupon rate.

Bonds trading at a discount generate a return both from receiving the coupons and from
receiving a face value that exceeds the price paid for the bond. As a result, the yield to maturity
of discount bonds exceeds the coupon rate.

6. Explain the relationship between interest rates and bond prices.

Bonds trading at a discount generate a return both from receiving the coupons and from
receiving a face value that exceeds the price paid for the bond. As a result, the yield to maturity
of discount bonds exceeds the coupon rate.

7. Why are longer-term bonds more sensitive to changes in interest rates than shorter term
bonds?

There is a greater probability that interest rates will rise (and thus negatively affect a bond's
market price) within a longer time period than within a shorter period. With short-term bonds,
this risk is not as significant because interest rates are less likely to substantially change in the
short term.

8. Explain why the expected return of a corporate bond does not equal its yield to maturity.

The yield to maturity of a corporate bond is based on the promised payments of the bond. But
there is some chance the corporation will default and pay less. Thus, the bonds expected return
is typically less than its YTM.

Corporate bonds have credit risk, which is the risk that the borrower will default and not pay all
specified payments. As a result, investors pay less for bonds with credit risk than they would for
an otherwise identical default-free bond. Because the YTM for a bond is calculated using the
promised cash flows, the yields of bonds with credit risk will be higher than that of otherwise
identical default free bonds. However, the YTM of a default able bond is always higher than the
expected return of investing in the bond because it is calculated using the promised cash flows
rather than the expected cash flows.

PROBLEMS
4. The following table summarizes prices of various default-free zero-coupon bonds
(Expressed as a percentage of face value):

Maturity (years) 1 2 3 4 5
Price (per $100 face value) $95.51 $91.05 $86.38 $81.65 $76.51

a. Compute the yield to maturity for each bond.

b. Plot the zero-coupon yield curve (for the first five years).

c. Is the yield curve upward sloping, downward sloping, or flat?

c. The yield curve is upward sloping.

Use the following information for Problems 57. The current zero-coupon yield curve for A risk-
free bond is as follows:

Maturity (years) 1 2 3 4 5
YTM 5.00% 5.50% 5.75% 5.95% 6.05%
5. What is the price per $100 face value of a two-year, zero-coupon, risk-free bond?

P = 100(1.055)2 = $89.85

6. What is the price per $100 face value of a four-year, zero-coupon, risk-free bond?

4
P = 100/(1.0595) = $79.36

7. What is the risk-free interest rate for a five-year maturity?

6.05%

8. For each of the following pairs of Treasury securities (each with $1000 par value),Identify which will
have the higher price:

a. A three-year zero-coupon bond or a five-year zero coupon bond?

b. A three-year zero-coupon bond or a three-year 4% coupon bond?
c. A two-year 5% coupon bond or a two-year 6% coupon bond?

A.The five-year will have the higher price because the present value is received sooner or the
future value is higher.

9. The yield to maturity of a $1000 bond with a 7% coupon rate, semiannual coupons, and two years to
maturity is 7.6% APR, compounded semiannually. What must its price be?
13. The prices of several bonds with face values of $1000 are summarized in the following table:

Bond A B C D
Price $972.50 $1040.75 $1150.00 $1000.00

For each bond, state whether it trades at a discount, at par, or at a premium.

Bond A trades at a discount. Bond D trades at par. Bonds B and C trade at a

premium.

14. You have purchased a 10% coupon bond for $1040. What will happen to the bonds price if
market interest rates rise?

15. Suppose a seven-year, $1000 bond with an 8% coupon rate and semiannual coupons is
trading with a yield to maturity of 6.75%.

a. Is this bond currently trading at a discount, at par, or at a premium? Explain.

b. If the yield to maturity of the bond rises to 7.00% (APR with semiannual compounding), what
price will the bond trade for?
Suppose that General Motors Acceptance Corporation issued a bond with ten years until
maturity, a face value of $1000, and a coupon rate of 7% (annual payments). The yield
to maturity on this bond when it was issued was 6%. Use this information for Problems
A-B-C.

A. What was the price of this bond when it was issued?

B. Assuming the yield to maturity remains constant, what is the price of the bond immediately
before it makes its first coupon payment?

C. Assuming the yield to maturity remains constant, what is the price of the bond immediately
after it makes its first coupon payment?