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Ch 09-19 Build a Model 3/5/2001

Chapter 9. Partial Model for Ch 09-19 Build a Model


Note: Fill in the shaded cells with the appropriate formulas

Rework Problem 9-9 using a spreadsheet. After completing questions a through d, answer the new question.
9-9. A 10-year 12 percent semiannual coupon bond, with a par value of $1,000, may be called in 4
years at a call price of $1,060. The bond sells for $1,100. (Assume that the bond has just been
issued.)

Work parts a through d with a spreadsheet. You can also work these parts with a calculator to check your
spreadsheet answers if you aren't confidient of your spreadsheet solution. You must then go on to work the
remaining parts with the spreadsheet.

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

Basic Input Data:


Years to maturity: 10
Periods per year: 2
Periods to maturity: 20
Coupon rate: 12%
Par value: $1,000
Periodic payment: $60
Current price $1,100
Call price: $1,060
Years till callable: 4
Periods till callable: 8

YTM = 5.18% This is a nominal rate, not the effective rate. Nominal rates are generally
quoted.

b. What is the bond's current yield?

Current yield = Ann. Coupon / Price


$60 / $1,100
5.45%

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

Cap. Gain/loss yield = YTM - Current yield


Cap. Gain/loss yield = 5.18% - 5.45%
Capital loss yield = -0.27%

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.

Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.
YTC = 5.07%

The YTC is much 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 interest rates? (Hint: Conduct a sensitivity analysis of
price to changes in the yield to maturity, which is also 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, k: 12%


Value of bond if it's not called: $551.83
Value of bond if it's called: $726.17 The bond would not be called unless k<coupon rate = 12%.

We can use the two valuation formulas to find values under different k'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, Hint: Use function Wizard and pick IF function.
Not called Called considering
Rate, k $551.83 $726.17 call likehood:
0% $2,200.00 $1,540.00 $1,540.00
2% $1,654.06 $1,344.23 $1,344.23
4% $1,271.81 $1,178.50 $1,178.50
6% $1,000.00 $1,037.64 $1,037.64
8% $803.64 $917.48 $917.48
10% $659.46 $814.59 $814.59
12% $551.83 $726.17 $551.83
14% $470.15 $649.92 $470.15
16% $407.12 $583.94 $407.12
18% $357.67 $526.65 $357.67
20% $318.26 $476.75 $318.26

Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.