Chapter 7

Bonds and Their Valuation

Problems

7-1 BOND VALUATION Madsen Motors’s bonds have 23 years remaining to maturity. Interest

is paid annually, they have a $1,000 par value, the coupon interest rate is 9%, and the yield

to maturity is 11%. What is the bond’s current market price?

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7-2 YIELD TO MATURITY AND FUTURE PRICE A bond has a $1,000 par value, 12 years to maturity, and an
8% annual coupon and sells for $980.

a. What is its yield to maturity (YTM)?

b. Assume that the yield to maturity remains constant for the next three years. What will

the price be 3 years from today?

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7-3 BOND VALUATION Nesmith Corporation’s outstanding bonds have a $1,000 par value, an

8% semiannual coupon, 14 years to maturity, and an 11% YTM. What is the bond’s price?

As 7-1

7-4 YIELD TO MATURITY A firm’s bonds have a maturity of 8 years with a $1,000 face value,

have an 11% semiannual coupon, are callable in 4 years at $1,154, and currently sell at a

price of $1,283.09. What are their nominal yield to maturity and their nominal yield to call?

What return should investors expect to earn on these bonds?

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7-5 BOND VALUATION An investor has two bonds in his portfolio that have a face value of

$1,000 and pay an 11% annual coupon. Bond L matures in 12 years, while Bond S matures

in 1 year.

a. What will the value of each bond be if the going interest rate is 6%, 8%, and 12%?

Assume that only one more interest payment is to be made on Bond S at its maturity

and that 12 more payments are to be made on Bond L.

b. Why does the longer-term bond’s price vary more than the price of the shorter-term

bond when interest rates change?

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7-6 BOND VALUATION An investor has two bonds in her portfolio, Bond C and Bond Z. Each

bond matures in 4 years, has a face value of $1,000, and has a yield to maturity of 8.2%.

Bond C pays an 11.5% annual coupon, while Bond Z is a zero-coupon bond.

a. Assuming that the yield to maturity of each bond remains at 8.2% over the next 4

years, calculate the price of the bonds at each of the following years to maturity:

Years to Maturity Price of Bond C Price of Bond Z

4 --------------- --------------

3 --------------- --------------

2 --------------- --------------

1 --------------- --------------

0 --------------- --------------

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266Part 3 Financial Assets

7-8 YIELD TO CALL Seven years ago the Templeton Company issued 20-year bonds with an
11% annual coupon rate at their $1,000 par value. The bonds had a 7.5% call premium,

with 5 years of call protection. Today Templeton called the bonds. Compute the realized

rate of return for an investor who purchased the bonds when they were issued and held

them until they were called. Explain why the investor should or should not be happy that

Templeton called them.

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7-9 YIELD TO MATURITY Harrimon Industries bonds have 6 years left to maturity. Interest is

paid annually, and the bonds have a $1,000 par value and a coupon rate of 10%.

a. What is the yield to maturity at a current market price of (1) $865 and (2) $1,166?

b. Would you pay $865 for each bond if you thought that a “fair” market interest rate for

such bonds was 12%—that is, if rd = 12%? Explain your answer.

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7-10 CURRENT YIELD, CAPITAL GAINS YIELD, AND YIELD TO MATURITY Pelzer Printing Inc. has

bonds outstanding with 9 years left to maturity. The bonds have a 9% annual coupon rate and

were issued 1 year ago at their par value of $1,000. However, due to changes in interest rates,

the bond’s market price has fallen to $910.30. The capital gains yield last year was −8.97%.

a. What is the yield to maturity?

b. For the coming year, what are the expected current and capital gains yields? (Hint:

Refer to footnote 6 for the definition of the current yield and to Table 7.1.)

c. Will the actual realized yields be equal to the expected yields if interest rates change?

If not, how will they differ?

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8-2 PORTFOLIO BETA An individual has $20,000 invested in a stock with a beta of 0.6 and

another $75,000 invested in a stock with a beta of 2.5. If these are the only two investments

in her portfolio, what is her portfolio’s beta?

8-3 REQUIRED RATE OF RETURN Assume that the risk-free rate is 5.5% and the required return

on the market is 12%. What is the required rate of return on a stock with a beta of 2?

8-4 EXPECTED AND REQUIRED RATES OF RETURN Assume that the risk-free rate is 3.5% and

the market risk premium is 4%. What is the required return for the overall stock market?

What is the required rate of return on a stock with a beta of 0.8?

8-5 BETA AND REQUIRED RATE OF RETURN A stock has a required return of 9%, the risk-free

rate is 4.5%, and the market risk premium is 3%.

a. What is the stock’s beta?

b. If the market risk premium increased to 5%, what would happen to the stock’s

required rate of return? Assume that the risk-free rate and the beta remain unchanged