University of Tunis

Tunis Business School

Principles of Finance
Tutorial n°4: Bonds, Features and Valuation
Professors: Dr. Ridha Esghaier
(Winter 2020)

Multiple Choice Questions:

Q1. The expected rate of return on a bond if bought at its current market price and held to maturity.
a. current yield
b. coupon yield
c. capital gains yield
d. yield to maturity

Q2. When the market's required rate of return for a particular bond is much less than its coupon rate, the bond is
selling at:
a. face value.
b. a discount.
c. a premium.
d. cannot be determined without more information.

Q3. If a bond sells at a high premium, then which of the following relationships hold true?
(P0 represents the price of a bond and rd is the bond's required rate of return (required yield to maturity.)
a. P0 < par and rd > the coupon rate.
b. P0 > par and rd > the coupon rate.
c. P0 > par and rd < the coupon rate.
d. P0 < par and rd < the coupon rate.

Q4. Which of the following statements is most correct?

a. If a bond’s required yield to maturity exceeds the coupon rate, the bond will sell at a premium over par.
b. All else equal, if a bond’s required yield to maturity increases, its current yield will fall.
c. All else equal, if a bond’s required yield to maturity increases, its price will fall.
d. None of the statements above is correct.

Q5. Which of the following statements is correct?

a. If a bond’s required yield to maturity exceeds its coupon rate, the bond’s current yield must also exceed
its coupon rate.
b. If a bond’s required yield to maturity exceeds its coupon rate, the bond’s price must exceed its face value.
c. If two bonds have the same maturity, the same yield to maturity, and the same level of risk, the bonds
should sell for the same price regardless of the bond’s coupon rate.
d. None of the statements above is correct.

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Exercise n°1: Nominal Yield to maturity

A $100 face value bond has a current market price of $93.5, an 8 percent coupon rate, and 10
years remaining until maturity. Interest payments are made semiannually.
a. Before you do any calculations, decide whether the yield to maturity is above or below the
coupon rate. Why?
b. What is the semiannual yield to maturity on this bond?
c. Using your answer to Part (b), what is the bond’s annual yield to maturity?

Solution 1

a. The yield to maturity is higher than the coupon rate of 8% because the bond sells at a
discount from its face value ($93.5 < $100).

With semi-annual payment; semiannual YTM = rd/2 solving:

 rd − 2 N 
INT  1 − (1 + 2 )  Par Value
PV B =   +
2 rd r
  (1 + d ) 2 N
 2  2
2N= 10 × 2 = 20; PV = $93.5; INT/2 = 0.08/2 × 100 = $4; Par value = 100
 rd − 20 
 1 − (1 + 2 )  100
93.5 = 4 ×   +
rd r
  (1 + d ) 20
 2  2

According to question a/ we know that rd/2 is higher than 8% /2 (rd/2 >4%)

• When we used 5% as our discount rate, we calculated the PVB to be $87.738

• When we used 4% as our discount rate, we calculated the PVB to be $100
• rd/2 is between these numbers (4% and 5%) . rd/2 (semi-annual YTM) will give us a fair
price (PVB) exactly equal to the current price of $93.5.

Using the linear interpolation system:

For rd/2 = 4% PVB = 100
rd/2 ? PVB = 93.5
for rd/2 = 5% PVB = 87.74

% .
=
% % .

rd/2 = semi-annual YTM = 4.53%

c. The annual YTM is : 2 × 4.53% = 9.06%

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Exercise n°2: Fair price and Yield to maturity

A Corporation is selling a new issue of bonds to raise money. The bonds will pay a coupon rate
of 10% and will mature in 6 years. The face value of the bonds is $1,000; interest is paid semi-
annually.
The market rate of interest is currently 8% for similar bonds.
a. What is the fair price for an investor to pay for one of these bonds?
b. If you pay the current price of $1,100 for a bond, what will be your yield-to-maturity?

Solution 2
 rd − 2 N 
INT  1 − (1 + 2 )  Par Value
a. Fair Price of the Bond: PV B =   +
2 rd r
  (1 + d ) 2 N
 2  2

2N = 2x 6=12; INT = 10% /2 x1,000 = $50 ; par value = 1,000; rd/2 = 8%/2 = 4%
 1 − ( 1 + 4 %) − 12  1 , 000
FairValue = 50   +
 4%  ( 1 + 4 %) 12

Fair Value = $1,093.85

b. Yield-to-maturity (or YTM) = 2x rd/2 solving:

 r d − 12 
 1 − (1 + 2 )  1 , 000
1 ,100 = 50   +
rd r
  ( 1 + d ) 12
 2  2

For rd/2 = 4% PVB = 1,093.85

rd/2 ? PVB = 1,100
For rd/2 = 3% PVB = 1,199.08

Using the linear interpolation system

rd/2 = the semi-annual yield-to-maturity = 3.94%

Annual YTM = 2x 3.94% = 7.88%

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Exercise n°3: Yield to Maturity, Current Yield and Capital Gain

A 10-year, 12% semiannual coupon bond, with a par value of $100 sells for $110. (Assume that
the bond has just been issued.)
a. What is the bond’s yield to maturity?
b. What is the bond’s current yield?
c. What is the bond’s capital gain or loss yield?

Solution 3
 rd − 2 N 
INT  1 − (1 + 2 )  Par Value
a. YTM ? Solving for rd/2 : PV B =   +
2 rd r
  (1 + d ) 2 N
 2  2
2N = 2x10 = 20, PVB = 110, INT/2 = 12% /2 x 100 = $6, Par Value = 100
 rd − 20 
 1 − (1 + 2 )  100
110 = 6 ×   +
rd r
  (1 + d ) 20
 2  2

Using rd/2 = 6% and rd/2 = 5% then the linear interpolation

rd/2 = 5.135% annual YTM = 2x 5.135% = 10.27%

b. The Current Yield =

%×
= = $12 / $110 = 10.91%.

c. YTM = Current yield + Capital gains yield

Capital Gains yield = 10.27% - 10.91% = - 0.64% (Capital Loss since it’s a premium bond)

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Exercise n°4: Bond pricing between 2 coupon dates

A Company issued an annual bond with these features :

Face value:$1000
Coupon rate i : 7%
Annual coupons
Issue date: July 1st, 2015
Maturity, July 1st, 2020
Compute the bond Full price on September 3rd, 2017 assuming that the market interest rate for that
type of bonds « rd » at this date is 9%. What is its Clean price at this date?
NB: year 2017: 365 days

Solution 4
Full Price:
1st step: the price of the bond just after the payment of the previous coupon July 1st 2017:
N = 3 coupons remaining
INT = 7% x 1,000 = 70
YTM = 9%
Par Value = $1,000

−3
 1 − (1 + 9%)  1,000
PV July 1st, 2017 = 70   + (1 + 9%) 3
= 949.37
 9% 

2nd step: Nber of days from the last coupon payment date and the current date

( from July 1st 2017 and September 3rd 2017) = 31 + 31 + 3 – 1 = 64 days

Total Nber of days per year : 365 days

3rd step: Capitalize the computed price until the current date using rd.

949.37 x (1 + 9%)64/365 = 963.82

Clean Price:
1st step :
The accrued interest = coupon value x the fraction of the coupon period
that has passed.
Accrued interest = $70 x (64/365) =$12.27
2nd step:
Clean price = full price - accrued interest
Clean Price = 963.82 – 12.27 = $ 951.55

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 Exercise n°5: Bond value in future time periods
A 20-year, $1,000 par value bond has a 9% annual coupon. The bond currently sells for $925.
If the yield to maturity remains at its current rate, what will the price be 5 years from now?

Solution 5
 1 − ( 1 + r d ) − 20  1 , 000
The actual YTM = rd for witch : 925 = 90   +
 rd  ( 1 + r d ) 20

N = 20 ; INT = 9% x $1,000 = 90$

Using linear interpolation YTM = rd = 9.87%
After 5 years: (it remains 15 years to reach maturity)
We suppose actual YTM = YTM5 = 9.87%
− 15
 1 − (1 + 9 . 87 %)  1, 000
PV Bafter 5 years = 90   + (1 + 9 . 87 %) 15 = $ 933 . 33
 9 . 87 % 
Exercise n°6: Determining the coupon rate and bond pricing between 2 coupon dates
On January 1st, 2016 a Company’s outstanding bonds have a $100 par value and mature in 5
years. Their yield to maturity is 9% and they pay semiannual interest. Their current market price is
$85.361 (on January 1st, 2016).
1- What is the bond's annual coupon interest rate i?
2- What would be the bond’s Full price on October 13, 2017? (assume the YTM remains the
same)
3- What is its clean price on October 13, 2017?

Solution 6:
1- We have to find the semiannual coupon payment (INT/2), then multiply it by 2 to get the annual
coupon, then divide it by the par value to find the annual coupon rate.
 r d − 2N 
INT  1 − (1 + 2 )  Par Value
PV B =   +
2 rd r
  (1 + d ) 2N
 2  2

2N= 2x 5 = 10 ; PVB = $85.361; Par Value = 100

YTM = 9% semiannual YTM = rd/2 = 9% /2 = 4,5%
INT  1 − (1 + 4.5%) − 10  100
85.361 =   +
 (1 + 4.5%)
10
2  4.5%
INT  1 − (1 + 4.5%) − 10  100
  = 85.361 −
2  4.5%  (1 + 4.5%) 10
INT
= $2.65 so Ammual Interest = 2 × $2.65 = $5.3
2
Annual coupon rate = $5.3 / $100 = 5.3%

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2- Full Price?
1st step: determine the value of the bond just after the date of the previous coupon payment
(July 1st 2017)
INT/2 = $2.65
Number of interest payments remaining = 7 among 10
YTM/2 = 4.5%

 1 − (1 + 4.5%) −7  100
PV July 1st, 2017 = 2.65 ×   + = $89 .09
 4 . 5 %  (1 + 4 . 5 %) 7

2nd Step:
Number of days from last coupon payment date (July 1st, 2017) to October 13, 2017:
= 31 + 31 + 30 + 13 -1 = 104 days
Total days in period (from july 1st 2017 to December 31 2017):
= 31 + 31 + 30 + 31 + 30 + 31 -1 = 183 days
rd
3 Step: Capitalize the computed price until the current date using rd.

89.09 x (1 + 4.5%)104/183 = $91.34

3- Clean Price?
1st step :
The accrued interest = coupon value x the fraction of the coupon period
that has passed.
Accrued interest = $2.65 x (104/183) =$1.50
nd
2 step:
Clean price = full price - accrued interest
Clean Price = 91.34 – 1.50 = $ 89.84

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