Question
Richard is a recent retiree who is interested in investing some of his savings in corporate bonds. His financial planner has suggested the following bonds:
Richard is a recent retiree who is interested in investing some of his savings in corporate bonds. His financial planner has suggested the following bonds:
- Bond A has an 11% annual coupon, matures in 12 years, and has a $1,000 face value.
- Bond B has a 15% annual coupon, matures in 12 years, and has a $1,000 face value.
- Bond C has a 7% annual coupon, matures in 12 years, and has a $1,000 face value.
A. Before calculating the prices of the bonds, indicate whether each bond is trading at a premium, at a discount, or at par. Bond A is selling at a ______ because its coupon rate is _______ the going interest rate. Bond B is selling at a _________ because its coupon rate is _______ the going interest rate. Bond C is selling at a ________ because its coupon rate is _________ the going interest rate.
B. Calculate the price of each of the three bonds. Round your answers to the nearest cent.
Price (Bond A): $ ______
Price (Bond B): $ ______
Price (Bond C): $ ______
C. Calculate the current yield for each of the three bonds. (Hint: The expected current yield is calculated as the annual interest divided by the price of the bond.) Round your answers to two decimal places. Current yield (Bond A): ____ % Current yield (Bond B): ____ % Current yield (Bond C): ____ %
D. If the yield to maturity for each bond remains at 11%, what will be the price of each bond 1 year from now? Round your answers to the nearest cent.
Price (Bond A): $ _____
Price (Bond B): $ _____
Price (Bond C): $ _____
| Bond A | Bond B | Bond C | |
| Expected capital gains yield | _____ % | _____ % | _____ % |
| Expected total return | _____ % | _____ % | _____ % |
E. Richard is considering another bond, Bond D. It has a 6% semiannual coupon and a $1,000 face value (i.e., it pays a $30 coupon every 6 months). Bond D is scheduled to mature in 9 years and has a price of $1,100. It is also callable in 5 years at a call price of $1,030.
- What is the bond's nominal yield to maturity? Round your answer to two decimal places. _____ %
- What is the bond's nominal yield to call? Round your answer to two decimal places. _____ %
- If Richard were to purchase this bond, would he be more likely to receive the yield to maturity or yield to call? Explain your answer. _____ %
Because the YTM is _____ the YTC, Richard _____ expect the bond to be called. Consequently, he would earn ____.
F. Explain briefly the difference between price risk and reinvestment risk.
- This risk of a decline in bond values due to an increase in interest rates is called _______. The risk of an income decline due to a drop in interest rates is called ______.
Which of the following bonds has the most price risk? Which has the most reinvestment risk?
- A 1-year bond with an 11% annual coupon
- A 5-year bond with an 11% annual coupon
- A 5-year bond with a zero coupon
- A 10-year bond with an 11% annual coupon
- A 10-year bond with a zero coupon
- _______ has the most price risk.
- ________ has the most reinvestment risk.
G. Calculate the price of each bond (A, B, and C) at the end of each year until maturity, assuming interest rates remain constant. Round your answers to the nearest cent.
GRAPH: Years Remaining until Maturity (Years 12-0) for Bond A, Bond B, Bond C. [Percentages]
G1. What is the expected current yield for each bond in each year? Round your answers to two decimal places.
GRAPH: Years Remaining until Maturity (12-1) for Bond A, Bond B, Bond C. [Percentages]
G2. What is the expected capital gains yield for each bond in each year? Round your answers to two decimal places.
| 1 Yrs Remaining | 2 | 3 | 4 | |
| 5 Until Maturity | 6 Bond A | 7 Bond B | 8 Bond C | |
| 9 12 | 10 | _____% | _____% | _____% |
| 14 11 | 15 | _____% | _____% | _____% |
| 19 10 | 20 | _____% | _____% | _____% |
| 24 9 | 25 | _____% | _____% | _____% |
| 29 8 | 30 | _____% | _____% | _____% |
| 34 7 | 35 | _____% | _____% | _____% |
| 39 6 | 40 | _____% | _____% | _____% |
| 44 5 | 45 | _____% | _____% | _____% |
| 49 4 | 50 | _____% | _____% | _____% |
| 54 3 | 55 | _____% | _____% | _____% |
| 59 2 | 60 | _____% | _____% | _____% |
| 64 1 | 65 | _____% | _____% | _____% |
| 69 | _____% | _____% | _____% |
G3. What is the total return for each bond in each year? Round your answers to two decimal places.
| Years Remaining | ||||
| Until Maturity | Bond A | Bond B | Bond C | |
| 12 | _____% | _____% | _____% | |
| 11 | _____% | _____% | _____% | |
| 10 | _____% | _____% | _____% | |
| 9 | _____% | _____% | _____% | |
| 8 | _____% | _____% | _____% | |
| 7 | _____% | _____% | _____% | |
| 6 | _____% | _____% | _____% | |
| 5 | _____% | _____% | _____% | |
| 4 | _____% | _____% | _____% | |
| 3 | _____% | _____% | _____% | |
| 2 | _____% | _____% | _____% | |
| 1 | _____% | _____% | _____% |
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Contemporary Financial Management
Authors: R. Charles Moyer, William J. Kretlow, James R. Mcguigan
7th Edition
0538877766, 9780538877763
