Chapter 5.

Ch 05 P24 Build a Model

a. What is the bond's yield to maturity? Basic Input Data: Years to maturity: Periods per year: Periods to maturity: Coupon rate: Par value: Periodic payment: Current price Call price: Years till callable: Periods till callable: YTM = 10.37%

10 2 20 12% $1,000 $60 $1,100 $1,060 4 8 This is a nominal rate, not the effective rate. Nominal rates are generally quoted.

b. What is the bond's current yield? Current yield = Annual Interest / Bond's Current Price $120 $1,100 10.91%

c. What is the bond's capital gain or loss yield? Cap. Gain/loss yield = YTM 10.37% -0.54% Current Yield 10.91%

Note that this is an economic loss, not a loss for tax purposes. d. What is the bond's yield to call? Here we can again use the Rate function, but with data related to the call. YTC = 10.15% This is a nominal rate, not the effective rate. Nominal rates are generally

quoted. The YTC is lower than the YTM because if the bond is called, the buyer will lose the difference between the call price and the current price in just 4 years, and that loss will offset much of the interest imcome. Note too that the bond is likely to be called and replaced, hence that the YTC will probably be earned. NOW ANSWER THE FOLLOWING NEW QUESTIONS: e. How would the price of the bond be affected by changing interest rates? (Hint: Conduct a sensitivity analysis of price to changes in the yield to maturity, which is also 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: Value of bond if it's not called: Value of bond if it's called: 12% $1,000.00 $1,037.64

The bond would not be called unless r<coupon rate = 12%.

We can use the two valuation formulas to find values under different r's, in a 2-output data table, and then use an IF statement to determine which value is appropriate: Value of Bond If: Actual value, Not called Called considering $1,000.00 $1,037.64 call likehood: $2,200.00 $1,540.00 $1,540.00 $1,902.28 $1,437.99 $1,437.99 $1,654.06 $1,344.23 $1,344.23 $1,446.32 $1,257.96 $1,257.96 $1,271.81 $1,178.50 $1,178.50 $1,124.62 $1,105.24 $1,105.24 $1,000.00 $1,037.64 $1,000.00 $894.06 $975.21 $894.06 $803.64 $917.48 $803.64 $726.14 $864.07 $726.14 $659.46 $814.59 $659.46 Hint: Use function Wizard and pick IF function.

Rate, r 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%

We can graph the above data to get another idea of the bond's price sensitivity.

Sensitivity Analysis
$2,500.00 $2,000.00 $1,500.00 Not called $1,000.00 $500.00 $0.00 0% 5% 10% 15% 20% 25% Rate, r Called Actual Value Consideration Value of the Bond

Rate, r

f. Now assume the date is 10/25/2007. Assume further that our 12%, 10-year bond was issued on 7/1/2007, is callable on 7/1/2011 for $1,060, will mature on 7/1/2017, pays interest semiannually (January 1 and July 1), and sells for $1,100. Use your spreadsheet to find (a) the bonds yield to maturity and (b) its yield to call. Refer to the Ch 09 Tool Kit for information about how to use Excel's bond valuation functions. The model finds the price of a bond, but the procedures for finding the yield are similar. Begin by setting up the input data as shown below: Basic info: Call info: Settlement (today) 10/25/2007 Same Maturity 1/7/2017 1/7/2011 True maturity for YTM, call date for YTC Coupon rate 12% Same Current price (% of par) 110 Same Redemption (% of par value) 100 106 Par for YTM, Call price for YTC Frequency (for semiannual) 2 Same Basis (360 or 365 day year) 0 Same With the input data set, put the pointer on D133 and then click fx, Financial, YIELD, OK to get the yield menu. Fill in the menu by using the point-and-click procedure, and then click OK to get the bond's yield, 10.34%: Yield to Maturity: 10.29% The completed menu is shown below. Tip: Use Yield function. For dates, either refer to cells D122 and D123, or enter the date in quotes, such as "10/25/2007".

D122 D123 D124 D125 D126

To find the yield to call, use the YIELD function, but with the call price rather than par value as the redemption

Yield to call:

9.90%

You could also use Excel's "Price" function to find the value of a bond between interest payment dates.