Question

You just bought a newly issued bond which has a face value of $1,000 and pays its coupon once annually. Its coupon rate is 5%, maturity is 20 years and the yield to maturity for the bond is currently 8%.

Do you expect the bond price to change in the future when the yield stays at 8%? Why or why not? Explain. (No calculation is necessary.)

2 marks)

Calculate what the bond price would be in one year if its yield to maturity stays at 8%.

Find the before-tax holding-period return for a one-year investment period if the bond sells at a yield to maturity of 7% by the end of the year (year 1).

marks)

When the ordinary income tax rate is higher than the capital gains tax rate, tax authorities typically tax anticipated price appreciations from bonds at the ordinary income rate in order to prevent tax aversion with discount bonds. Suppose that from the total dollar return in part c), the coupon payment and the difference between the hypothetical prices in part b) and the purchase price are taxed at the ordinary income tax rate, 40%. The rest of the dollar return is considered capital gains (due to unanticipated change in yield-to-maturity from 8% to 7%) taxed at 30%. In other words, coupon payments and the anticipated price appreciation are taxed at the ordinary income tax rate and the rest at the lower capital gains rate. Using your answers in part b) and c), calculate the after-tax holding period return over one year if the yield to maturity is 7% at the end of the year.

5 marks)

Find the realized compound yield before taxes for a two-year holding period, assuming that 1) investor who bought the newly issued bond now will sell the bond in two years, ii) bond’s yield-to-maturity will be 7% at the end of the second year, and iii) the coupon in year 1 will be reinvested for one year at a 3% interest rate. Ignore taxes.

Answer #1

When the market yield increases, the bond price will fall. The cash flows are discounted at a higher rate.

At a lower price, the bond’s yield to maturity will be higher. The higheryield to maturity on the bond is commensurate with the higher yields available in the rest of the bond market.

Current yield = coupon payment/bond price. As coupon payment remains the same and the bond price decreases, the current yield increases

Coupon payment = .08 x 1000 =
$80

Current yield = 80/bond price = .075

Therefore, bond price = 80/.075 = $1,066.67

Per period rate is 7%/2 = 3.5%

Price = 40 × annuity factor(3.5%,
18 years) + 1000/1.035^{18} = $1,065.95

A newly issued bond pays its coupons once a year. Its coupon
rate is 4%, its maturity is 10 years, and its yield to maturity is
7%.
a. Find the holding-period return for a one-year
investment period if the bond is selling at a yield to maturity of
6% by the end of the year. (Do not round intermediate
calculations. Round your answer to 2 decimal places.)
Holding-period return
%
b. If you sell the bond after one year when...

A newly issued bond pays its coupons once a year. Its coupon
rate is 4.4%, its maturity is 15 years, and its yield to maturity
is 7.4%.
a.
Find the holding-period return for a one-year investment period
if the bond is selling at a yield to maturity of 6.4% by the end of
the year. (Do not round intermediate
calculations. Round your answer to 2 decimal places.)
Holding-period return
%
b.
If you sell the bond after one year when...

Consider a bond that pays 6% annual coupon on a face value of
$1000 and has 5 years to maturity. Suppose you buy the bond at a
time when its yield to maturity is 10%. Assumer further that
immediately after you buy the bond, the market interest rate YTM
declines to 8%. You hold the bond for two years and sell it at the
end of the second year when YTM is still 8%.
a) Calculate the annualized two year...

(Bond valuation) At the beginning of the year, you bought a $1,000
per value corporate bond with an annual coupon rate of 8 percent
and a maturity date of 15 years. When you bought the bond, it had
an expected yield to maturity of 11 percent. Today the bond sells
for $920.
a. What did you pay for the bond?
b. If you sold the bond at the end of the year, what would be
your one-period return on the...

Bond A is a $1,000, 6% quarterly coupon bond with 5 years to
maturity.
(a) If you bought Bond A today at a yield (APR) of 8%, what is
your purchase price? Is this a premium or discount bond? Why?
(b) One year later, Bond A's YTM (APR) has gone down to 6% and
you sell it immediately after receiving the coupon.
(i) What is the current yield?
(ii) What is the capital gains yield?
(iii) What is the one-year...

One year ago, you bought a bond at a price of $992.6000.The bond
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face value of $1,000 and would mature in 5 years. Today, the bond
just paid its coupon and the yield to maturity is 8%. What is your
holding period return in the past year? (suppose you did not
reinvest coupons)

Bond Valuation
C) Suppose that Joan just bought a 15-year bond
for $902.71. The bond has a coupon rate equal to 7 percent, and
interest is paid semiannually. What is the bond’s yield to maturity
(YTM)? If Joan holds the bond for the next three years and its YTM
does not change during that period, what return will she earn each
year? What portion of the annual return represents capital gains
and what portion represents the current yield?
D) Suppose...

(Bond valuation) At the beginning of the year, you bought a
$ 1,000 par value corporate bond with an annual coupon rate of 14
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Chapter 6 Spreadsheet
Problem
Bond
Valuation
Jenna bought a
bond that was issued by Sherlock Watson Industries (SWI) three
years ago. The bond has a $1,000 maturity value, a coupon rate
equal to 9 percent, and it matures in 17 years. Interest is paid
every six months; the next interest payment is scheduled for six
months from today.
a.
If the yield on similar risk investments is 12 percent, what is the
current market value (price) of the bond?...

Bond A is a $1,000, 6% quarterly coupon bond with 5 years to
maturity.
(a) If you bought Bond A today at a yield (APR) of 8%, what is
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(b) One year later, Bond A's YTM (APR) has gone down to 6% and
you sell it immediately after receiving the coupon.
(i) What is the current yield?
(ii) What is the capital gains yield?
(iii) What is the one-year...

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