Chapter 5_Build a Model Spreadsheet

Bonds, Build a Model

Build a Model Solution4/11/10Chapter 5. Solution to Ch05 P24 Build a ModelA 20-year, 8% semiannual coupon bond with a par value of $1,000 may be called in 5 years at a call price of $1,040. The bond sells for $1,100. (Assume that the bond has just been issued.)Basic Input Data:Years to maturity:20Periods per year:2Periods to maturity:40Coupon rate:8%Par value:$1,000Periodic payment:$40Current price$1,100Call price:$1,040Years till callable:5Periods till callable:10a. What is the bond's yield to maturity?Peridodic YTM =3.53%Annualized Nominal YTM =7.06%Hint: This is a nominal rate, not the effective rate. Nominal rates are generally quoted.b. What is the bond's current yield?Current yield =Ann. Coupon /PriceHint: Write formula in words.Current yield =$80/$1,100Hint: Cell formulas should refer to Input SectionCurrent yield =7.27%(Answer)c. What is the bond's capital gain or loss yield?Cap. Gain/loss yield =YTM-Current yieldHint: Write formula in words.Cap. Gain/loss yield =7.06%-7.27%Hint: Cell formulas should refer to Input SectionCap. Gain/loss yield =-0.21%(Answer)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.Peridodic YTC =3.16%Annualized Nominal YTC =6.33%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 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:8%Value of bond if it's not called:$1,000.00Value of bond if it's called:$1,027.02The bond would not be called unless r