Question

Bonds often pay a coupon twice a year. For the valuation of bonds that make semiannual payments, the number of periods doubles, whereas the amount of cash flow decreases by half. Using the values of cash flows and number of periods, the valuation model is adjusted accordingly.

Assume that a $1,000,000 par value, semiannual coupon US Treasury note with five years to maturity has a coupon rate of 3%. The yield to maturity (YTM) of the bond is 11.00%. Using this information and ignoring the other costs involved, calculate the value of the Treasury note:

a. $593,720.72

b. $698,494.97

c. $838,193.96

d. $440,051.83

Based on your calculations and understanding of semiannual coupon bonds, complete the following statement:

Assuming that interest rates remain constant, the T-note’s price is expected to _____ (decrease/increase).

Answer 1

Answer : Correct Option is b. $698,494.97

Calculations :

Calcculation of Present Value of T-Note :

Present Value can be calculated using PV function of Excel :

=PV(rate,nper,pmt,fv)

where

rate is rate of interest per period i.e 11% / 2 = 5.5% (Divided by 2 as semiannual payments)

nper is the number of years to amturity i.e 5 * 2 = 10 (Multiplied by 2 as semiannual payments)

pmt is 1,000,000 * 3% / 2 = 15000 (Divided by 2 as semiannual payments)

fv is the par value or face value i.e 1,000,0003

=PV(5.5%,10,-15000,-1000000)

Value of Treasury Note is 698,494.97

Assuming that interest rates remain constant, the T-note’s price is expected to INCREASE.(As it is currently trading at discount)