Problems 193

Self-Test Problem Solution Appears in Appendix A

The Pennington Corporation issued a new series of bonds on January 1, 1984. The
bonds were sold at par ($1,000), had a 12% coupon, and matured in 30 years, on
December 31, 2013. Coupon payments are made semiannually (on June 30 and
(ST-1) December 31).
Bond Valuation a. What was the YTM on January 1, 1984?
b. What was the price of the bonds on January 1, 1989, 5 years later, assuming
that interest rates had fallen to 10%?
c. Find the current yield, capital gains yield, and total return on January 1, 1989,
given the price as determined in part b.
1
d. On July 1, 2007, 5 ⁄ years before maturity, Pennington’s bonds sold for $916.42.
2

What were the YTM, the current yield, the capital gains yield, and the total
return at that time?
e. Now, assume that you plan to purchase an outstanding Pennington bond
on March 1, 2007, when the going rate of interest given its risk is 15.5%. How
large a check must you write to complete the transaction? This is a hard question.

Easy Problems 1–6 Problems Answers Appear in Appendix B

(5-1) Jackson Corporation’s bonds have 12 years remaining to maturity. Interest is paid
Bond Valuation with annually, the bonds have a $1,000 par value, and the coupon interest rate is 8%. The
Annual Payments bonds have a yield to maturity of 9%. What is the current market price of these bonds?

(5-2) Wilson Wonders’ bonds have 12 years remaining to maturity. Interest is paid
Yield to Maturity for annually, the bonds have a $1,000 par value, and the coupon interest rate is 10%.
Annual Payments The bonds sell at a price of $850. What is their yield to maturity?

(5-3) Heath Foods’ bonds have 7 years remaining to maturity. The bonds have a face
Current Yield for Annual value of $1,000 and a yield to maturity of 8%. They pay interest annually and have
Payments a 9% coupon rate. What is their current yield?

(5-4) The real risk-free rate of interest is 4%. Inflation is expected to be 2% this year and 4%
Determinant of Interest during the next 2 years. Assume that the maturity risk premium is zero. What is the
Rates yield on 2-year Treasury securities? What is the yield on 3-year Treasury securities?

(5-5) A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate
Default Risk Premium bond has a yield of 9%. Assume that the liquidity premium on the corporate bond
is 0.5%. What is the default risk premium on the corporate bond?

(5-6) The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years.
Maturity Risk Premium A 2-year Treasury security yields 6.3%. What is the maturity risk premium for the
2-year security?
Intermediate
Problems 7–20
(5-7) Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually.
Bond Valuation with The bonds mature in 8 years, have a face value of $1,000, and a yield to maturity
Semiannual Payments of 8.5%. What is the price of the bonds?
194 Chapter 5 Bonds, Bond Valuation, and Interest Rates

(5-8) Thatcher Corporation’s bonds will mature in 10 years. The bonds have a face
Yield to Maturity and Call value of $1,000 and an 8% coupon rate, paid semiannually. The price of the bonds
with Semiannual is $1,100. The bonds are callable in 5 years at a call price of $1,050. What is their
Payments yield to maturity? What is their yield to call?

(5-9) The Garraty Company has two bond issues outstanding. Both bonds pay $100
Bond Valuation and annual interest plus $1,000 at maturity. Bond L has a maturity of 15 years, and
Interest Rate Risk Bond S a maturity of 1 year.
a. What will be the value of each of these bonds when the going rate of interest
is (1) 5%, (2) 8%, and (3) 12%? Assume that there is only one more interest pay-
ment to be made on Bond S.
b. Why does the longer-term (15-year) bond fluctuate more when interest rates
change than does the shorter-term bond (1 year)?

(5-10) The Brownstone Corporation bonds have 5 years remaining to maturity. Interest
Yield to Maturity and is paid annually; the bonds have a $1,000 par value; and the coupon interest rate
Required Returns is 9%.
a. What is the yield to maturity at a current market price of (1) $829 or (2) $1,104?
b. Would you pay $829 for one of these bonds if you thought that the appropri-
ate rate of interest was 12%—that is, if rd  12%? Explain your answer.

(5-11) Seven years ago, Goodwynn & Wolf Incorporated sold a 20-year bond issue with
Yield to Call and a 14% annual coupon rate and a 9% call premium. Today, G&W called the bonds.
Realized Rates of Return The bonds originally were sold at their face value of $1,000. Compute the realized
rate of return for investors who purchased the bonds when they were issued and
who surrender them today in exchange for the call price.

(5-12) A 10-year, 12% semiannual coupon bond with a par value of $1,000 may be called
Bond Yields and in 4 years at a call price of $1,060. The bond sells for $1,100. (Assume that the bond
Rates of Return 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?
d. What is the bond’s yield to call?

(5-13) You just purchased a bond that matures in 5 years. The bond has a face value of
Yield to Maturity and $1,000 and has an 8% annual coupon. The bond has a current yield of 8.21%. What
Current Yield is the bond’s yield to maturity?

(5-14) A bond that matures in 7 years sells for $1,020. The bond has a face value of $1,000
Current Yield with and a yield to maturity of 10.5883%. The bond pays coupons semiannually. What
Semiannual Payments is the bond’s current yield?

(5-15) Absolom Motors’ 14% coupon rate, semiannual payment, $1,000 par value bonds
Yield to Call, Yield to that mature in 30 years are callable 5 years from now at a price of $1,050. The
Maturity, and bonds sell at a price of $1,353.54, and the yield curve is flat. Assuming that interest
Market Rates rates in the economy are expected to remain at their current level, what is the best
estimate of the nominal interest rate on new bonds?