ADM 2350 Lecture Notes - Interest Rate Risk, Premium Bond, Risk Premium

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bronzeyak402

18 Feb 2014

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If the ytm is greater than the coupon rate, the par value is greater than the bond price and it is a discount bond/bond price. If the ytm is less than the coupon rate, the par value is less than the bond price and it is a premium bond/bond price. The longer the term to maturity, the greater the interest rate risk. The lower the coupon rate, the greater the interest rate risk. R = nominal rate of interest r = real rate of interest h= expected inflation rate. Factors affecting required return: default risk premium bond rating. If dividends are expected at regular intervals forever, then this valued as a perpetuity. The price grows at the same rate as the dividends in the constant growth model. Suppose a firm is expected to increase dividends by 20% in one year and by 15% in two years. After that dividends will increase at a rate of 5% per year indefinitely.

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A 20-year, 5.75% semiannual coupon bond with a par value of $1,000 may be called in 5 years at a call price of $1,060. The bond sells for $1,010. (Assume that the bond has just been issued.)

Basic Input Data
Years to Maturity:	20
Periods Per Year:	2
Periods to Maturity:	40
Coupon Rate:	5.75%
Par Value:	$1,000
Periodic Payment:	$28.75
Current Price:	$1,010
Call Price:	$1,060
Years till Callable:	5
Periods till Callable:	10

Yield to Maturity

Periodic YTM =	3.27%
Annualized Nominal YTM =	6.55%

Current Yield

Current Yield =

Annual Coupon

Hint: Write formula in words.

Current Yield =

$58

Hint: Cell formulas should refer

to Basic Input Data Section

Current Yield =

0.0569

Yield to Call

Peridodic YTC =

2.91%

Annualized Nominal YTC =

5.83%

This is a nominal rate, not effective rate.

Nominal rates are generally quoted.

When the YTC is lower than the YTM and if the bond is called, the buyer will lose the difference between the call price and the current price between the purchase date and the call date, and that loss would offset much of the interest income. Note too that if the YTC is lower than the YTM then the bond is likely to be called and replaced, hence that the YTC would probably be earned.

Nominal market rate, r:	6%
Value of bond if it's not called:	$971.11
Value of bond if it's called:	$1,033.98

a. Assume you have been asked to evaluate investing some excess cash into the bond described above. Recommend purchasing the bond or looking at another option. Defend your recommendation by explaining the items above.

b. How would the price of the bond be affected by changing the going market interest rate?

plumalligator846

If a bond is currently trading at its face (par) value, then it must be the case that:

		the bond's yield to maturity is less than its coupon rate.
		the bond's yield to maturity is greater than its coupon rate.
		the bond is a zero-coupon bond.
		the bond's yield to maturity is equal to its coupon rate.

maroonllama551

For this problem, assume you have been asked to evaluate investing some excess cash into the bond described below. When complete, recommend purchasing or looking at another option. Defend your recommendation by explaining the items you calculated.

A 20-year, 5.75% semiannual coupon bond with a par value of $1,000 may be called in 5 years at a call price of $1,060. The bond sells for $1,010. (Assume that the bond has just been issued.)

Basic Input Data
Years to Maturity:	20
Periods Per Year:	2
Periods to Maturity:	______
Coupon Rate:	5.75%
Par Value:	$1,000
Periodic Payment:	______
Current Price:	$1,010
Call Price:	$1,060
Years till Callable:	5
Periods till Callable:	______

a. What is the bond's yeild to maturity?

Periodic YTM =	______
Annualized Nominal YTM =	______

Hint: This is a nominal rate, not the effective rate. Nominal rates are generally quoted.

b. What is the bond's current yeild?

Current Yield =

______

Hint: Write formula in words.

Current Yield =

______

Hint: Cell formulas should refer

to Basic Input Data Section

Current Yield =

(Answer)

c. What is the bond's yield to call?

Here we can again use the Rate function, but with data related to the call.

Peridodic YTC =

______

Annualized Nominal YTC =

______

This is a nominal rate, not effective rate.

Nominal rates are generally quoted.

e. How would the price of the bond be affected by changing the going market interest rate? (Hint: Conduct a sensitivity analysis of price to changes in the going market interest rate for the bond. Assume that the bond will be called if and only if the going rate of interest falls below the coupon rate. That is an oversimplification, but assume it anyway for purposes of this problem.)

Nominal market rate, r:	6%
Value of bond if it's not called:	______
Value of bond if it's called:	______

sangriascorpion633

ADM 2350 Lecture Notes - Interest Rate Risk, Premium Bond, Risk Premium

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