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Valuation and Bond Analysis Exercises

Exercises

Question 1
What is the three step approach for security valuation and how do I apply it to bond pricing?

Question 2
What is the relationship between market rates of interest and bond prices?

Question 3
How does the length of time until maturity for a bond impact the relationship between market rates of interest and bond prices?

Question 4
If a bond will pay me $1000 upon maturity, why would I ever be willing to pay a premium to purchase it today?

Question 5
What is a call provision?

Question 6
What is more relevant to an investor

  • 6a. Yield-to-Maturity or Coupon Rate?
  • 6b. Yield-to-Maturity or Yield-to-Call?

Question 7
Why are bond ratings important?

Question 8
Which bond should have a higher YTM:

  • A 20-year bond with a AA rating, or a 20-year bond with a BB rating?
  • A 30-year bond with an A rating or a 5-year bond with a BB rating?


Question 9
Because junk bonds have a higher probability of default than investment-grade bonds, they are a poor investment tool and we should expect to earn lower rates of return on them. True or False?  Explain.

Question 10
Which is more sensitive to a change in interest rates, a zero-coupon bond or a 10% coupon bond? Why might this be?

Question 11
Would you ever pay more than $1000 to buy a $1000 non-convertible zero coupon bond? Explain.

Problem 1
Find the price for a 7.5% coupon bond under the following conditions.

1a. 30 years to maturity, required return is 9%
1b. 30 years to maturity, required return is 7.5%
1c. 30 years to maturity, required return is 6%
1d. 10 years to maturity, required return is 9%
1e. 10 years to maturity, required return is 7.5%
1f. 10 years to maturity, required return is 6%
1g. 2 years to maturity, required return is 9%
1h. 2 years to maturity, required return is 7.5%
1i. 2 years to maturity, required return is 6%

Problem 2
The current price of a 4.25% coupon bond with 10 years to maturity is $918.23, what is the YTM?

Problem 3
The current price of a 9.75% coupon bond with 20 years to maturity is $1318, what is the YTM? If the bond contains a call provision that allows the company to call the bond for $1050 7-years from now, what is the YTC? Based on the available information, is this bond likely to be called?

Problem 4
Find the price of a 20-year zero coupon bond if the required return on such a bond was 12%? What if the required return was 10%?

Problem 5
Ten years ago you purchased a 30-year 9% coupon bond. At that time, the market rate of interest was 6.5%. Today, you sell the bond (the current market rate of interest is 10.5%).

5a. How much did you pay for the bond when you purchased it 10 years ago?
5b. How much can you sell the bond for today?
5c. What rate of return did you earn on your investment over the 10-year period that you held the bond?

Source: Kevin Bracker, Fang Lin, Jennifer Pursley, https://businessfinanceessentials.pressbooks.com/chapter/chapter-4-valuation-and-bond-analysis/
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