Workshop problems 1: Interest rates and Bonds

1. Consider the following returns and yields: U.S. T-bill = 8%, 5-year U.S. T-note =
7%, IBM
common stock = 15%, IBM AAA Corporate Bond = 12% and 10-year U.S. T-bond
= 6%. Based on this information, what is the the shape of the yield curve?

2. A firm has an issue of R1,000 par value/face value bonds with a 12 percent
stated interest rate outstanding. The issue pays interest annually and has 10
years remaining to its maturity date. If bonds of similar risk are currently earning
8 percent, what would the firms bond will sell for today.

3. Nico Corp issued bonds bearing a coupon rate of 12 percent, pay coupons
semiannually, have 3 years remaining to maturity, and are currently priced at
R940 per bond. What is the yield to maturity?

4. Paul Petersen wishes to estimate the value of an asset expected to provide

cash inflows of R3000 per year at the end of years 1 to 4 and R 15000 at the end
of year 5. His research indicates that he must earn 10% on low-risk assets, 15%
on average risk assets and 22% on high risk assets.
a) Please determine what is the most he ought to pay for the asset if it is
classified as low risk, average risk and high risk.
b) Suppose he is unable to assess the risk of the asset and wants to be certain
hes making a good deal. On the basis of your findings in (a) what is the most he
ought to pay and why?
c) Assuming all else remains constant, what impact does increasing risk have on
the value of an asset.

5. You were offered two bonds. Each has a maturity of five years, a par value of
R1000 and a yield to maturity of 12%. Bond A and B have coupon interest rates
of 6% and 14%, respectively. The coupon interest payments on both bonds are
paid annually.
a) Calculate the selling price for each of the bonds.
b) Suppose you have R20,000 to invest. On the basis of price of the bonds, how
many of either one can you buy, if you were to choose it over the other?
c) Assuming that you re-invest the interest payments as they are paid (at the
end of each year) and that the rate of return on the re-investments is only 10%.
For both bonds calculate the value of the principal payments plus the par value
at the end of the 5 years.

6. Suppose your company needs to raise R15 million and you want to issue 30
year R1000 nominal value bonds for this purpose. The yield to maturity (required
rate of return) on the bond is 7%, and two alternatives are being considered; a
8% annual coupon bond and a zero coupon bond. Taxes are zero percent.
a) How many of the coupon bonds would you need to issue to raise the R15
million rand today? How many of the zero coupon bonds would you need to issue
to raise the R10 million rand today?
b) In 30 years, What will your companys repayment be if you issue the coupon
bonds? What will it be if you issue the zero coupon bonds
7. Suppose you buy (lend) a 9% coupon bond making annual payments today for
R1200. The bond has 10 years to maturity.
a) What rate of return (YTM) do you expect to earn on your investment?
b) What would the rate of return be on your investment if coupons were paid
semi-annually?
c) With reference to a, two years from now the YTM has declined by 2.5% , and
you decide to sell.
i. What price will your bond sell for?
ii. What would be your return on the bond if sold?
iii. What is annual rate of return?