USING EXCEL:

• Exercise 2:

If the first bond in exercise 1 has a yield to maturity of 8% one year from now, what will its price be?

What will be the rate of return on the bond?

If the inflation rate during the year is 3%, what is the real return on the bond?

HERE IS EXERICE 1:

One bond has a coupon rate of 8%, another a coupon of 12%. Both bonds have 10-year maturities and sell at a yield to maturity of 10%. If their yields to maturity next year are still 10%, what is the rate of return on each bond? Does the higher coupon bond give a higher rate of return?

Solution ex1:

Computation of the rate of return on each bond over the next year, shown in the below sheet:

	A	B	C
1		Bond A	Bond B
2	Par value	$1,000	$1,000
3	Coupon rate	8%	12%
4	Coupon amount	$80	$120
5	Years to maturity	10	10
6	Yield to Maturity	10%	10%
7	>>>
8	Current price of the bond	$877.11	$1,122.89
9	Price of the bond next year	$884.82	$1,115.18
10
11	Rate of Return in year-1	10.00%	10.00%

Cell reference:

	A	B	C
1		Bond A	Bond B
2	Par value	1000	1000
3	Coupon rate	0.08	0.12
4	Coupon amount	=B2*B3	=C2*C3
5	Years to maturity	10	10
6	Yield to Maturity	0.1	0.1
7	>>>
8	Current price of the bond	=PV(B6,B5,-B4,-B2)	=PV(C6,C5,-C4,-C2)
9	Price of the bond next year	=PV(B6,B5-1,-B4,-B2)	=PV(C6,C5-1,-C4,-C2)
10
11	Rate of Return in year-1	=RATE(1,-B4,B8,-B9)	=RATE(1,-C4,C8,-C9)

Explanation:

Excel function "=PV(rate,nper,pmt,fv)" is used to compute the price of the bond.

where,

rate = YTM

nper = Years until maturity

pmt = Coupon amount

fv = Par value

PV = Price of the bond

Excel function "=RATE(nper,pmt,pv,fv)" is used to compute the rate of return.

where,

nper = Holding period ( i.e. 1 year in this case)

pmt = Coupon amount per year

pv = Current price of the bond|

fv = Price of the bond next year

RATE = Rate of return