Chapter 07 – Valuing Bonds
CHAPTER 7 – VALUING BONDS
questions
LG1 1. What does a call provision allow issuers to do, and why would they do it?
LG2 2. List the differences between the new TIPS and traditional Treasury bonds.
Traditional Treasury bonds have a fixed principal and constant interest payments. Because the
LG2 3. Explain how mortgage-backed securities work.
LG3 4. Provide the definitions of a discount bond and a premium bond. Give examples.
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Chapter 07 – Valuing Bonds
LG4 5. Describe the differences in interest payments and bond price between a 5 percent coupon bond
and a zero coupon bond.
LG5 6. All else equal, which bond’s price is more affected by a change in interest rates, a short-term
LG5 7. All else equal, which bond’s price is more affected by a change in interest rates, a bond with a
large coupon or a small coupon? Why?
LG5 8. Explain how a bond’s interest rate can change over time even if interest rates in the economy
do not change.
LG6 9. Compare and contrast the advantages and disadvantages of the current yield computation
versus yield to maturity calculations.
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Chapter 07 – Valuing Bonds
LG6 10. What is the yield to call and why is it important to a bond investor?
LG6 11. What is the purpose of computing the equivalent taxable yield of a municipal bond?
LG6 12. Explain why high income and wealthy people are more likely to buy a municipal bond than a
corporate bond.
LG7 13. Why does a Treasury bond offer a lower yield than a corporate bond with the same time to
maturity? Could a corporate bond with a different time to maturity offer a lower yield? Explain.
LG7 14. Describe the difference between a bond issued as a high-yield bond and one that has become
a “fallen angel.”
Chapter 07 – Valuing Bonds
LG8 15. What is the difference in the trading volume between Treasury bonds and corporate bonds?
Give examples and/or evidence.
There is high trading volume in Treasury bonds and low trading volume in corporate bonds.
problems
basic problems
LG1 7-5 Call Premium A 6 percent corporate coupon bond is callable in five years for a call premium
of one year of coupon payments. Assuming a par value of $1,000, what is the price paid to the
bondholder if the issuer calls the bond?
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Chapter 07 – Valuing Bonds
LG1 7-6 Call Premium A 5.5 percent corporate coupon bond is callable in 10 years for a call
premium of one year of coupon payments. Assuming a par value of $1,000, what is the price
paid to the bondholder if the issuer calls the bond?
LG2 7-7 TIPS Interest and Par Value A 2.75 percent TIPS has an original reference CPI of 185.4. If
the current CPI is 210.7, what is the current interest payment and par value of the TIPS?
LG2 7-8 TIPS Interest and Par Value A 3.125 percent TIPS has an original reference CPI of 180.5.
If the current CPI is 206.8, what is the current interest payment and par value of the TIPS?
LG3 7-9 Bond Quotes Consider the following three bond quotes; a Treasury note quoted at 97:27,
and a corporate bond quoted at 103.25, and a municipal bond quoted at 101.90. If the Treasury
and corporate bonds have a par value of $1,000 and the municipal bond has a par value of
$5,000, what is the price of these three bonds in dollars?
LG3 7-10 Bond Quotes Consider the following three bond quotes; a Treasury bond quoted at 106:14,
a corporate bond quoted at 96.55, and a municipal bond quoted at 100.95. If the Treasury and
corporate bonds have a par value of $1,000 and the municipal bond has a par value of $5,000,
what is the price of these three bonds in dollars?
LG4 7-11 Zero Coupon Bond Price Calculate the price of a zero coupon bond that matures in 20
years if the market interest rate is 3.8 percent.
Use semiannual compounding:
Chapter 07 – Valuing Bonds
PV =FV N
(
1+i
)
N=$1, 000
(
1+. 038
2
)
40 =$471 .01
LG4 7-12 Zero Coupon Bond Price Calculate the price of a zero coupon bond that matures in 15
years if the market interest rate is 5.75 percent.
Use semiannual compounding:
PV =FV N
(
1+i
)
N=$1, 000
(
1+. 0575
2
)
30 =$427 .27
LG6 7-13 Current Yield What is the current yield of a 3.8 percent coupon corporate bond quoted at a
price of 102.08?
LG6 7-14 Current Yield What is the current yield of a 5.2 percent coupon corporate bond quoted at a
price of 96.78?
LG6 7-15 Taxable Equivalent Yield What is the taxable equivalent yield on a municipal bond with a
yield to maturity of 3.5 percent for an investor in the 33 percent marginal tax bracket?
Use equation 7.4:
Muni yield 3.5%
Equivalent taxable yield 5.22%
1-Tax rate 1 0.33
= = =
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Chapter 07 – Valuing Bonds
Chapter 07 – Valuing Bonds
LG7 7-18 Credit Risk and Yield Rank the following bonds in order from lowest credit risk to highest
risk, all with the same time to maturity, by their yield to maturity: Treasury bond with yield of
4.65 percent, United Airline bond with yield of 9.07 percent, Bank of America bond with a yield
of 6.25 percent, and Hewlett/Packard bond with yield of 6.78 percent.
intermediate problems
LG2 7-19 TIPS Capital Return Consider a 3.5 percent TIPS with an issue CPI reference of 185.6. At
the beginning of this year, the CPI was 193.5 and was at 199.6 at the end of the year. What was
the capital gain of the TIPS in dollars and in percentage terms?
LG2 7-20 TIPS Capital Return Consider a 2.25 percent TIPS with an issue CPI reference of 187.2.
At the beginning of this year, the CPI was 197.1 and was at 203.8 at the end of the year. What
was the capital gain of the TIPS in dollars and in percentage terms?
LG4 7-21 Compute Bond Price Compute the price of a 3.8 percent coupon bond with 15 years left to
maturity and a market interest rate of 6.8 percent. (Assume interest payments are semiannual.) Is
this a discount or premium bond?
Bond Price = $19 . 00×
[
1−1
(
1+0 . 034
)
30
0. 034
]
+$1,000
(
1+0 . 034
)
30 =$353 . 869+$366 . 762=$720 .63
or TVM calculator: N = 30, I = 3.4, PMT = 19.00, FV = 1000; CPT PV = -720.63
Since the bond’s price is less than $1,000, it is a discount bond.
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