SOLUTIONS TO END-OF-CHAPTER PROBLEMS

9-1

With your financial calculator, enter the following:

N = 10; I = YTM = 9%; PMT = 0.08 1,000 = 80; FV = 1000; PV = VB = ?
PV = $935.82.
Alternatively,
VB =
=
=
=

9-2

$80(PVIFA9%,10) + $1,000(PVIF9%,10)
$80((1- 1/1.0910)/0.09) + $1,000(1/1.0910)
$80(6.4177) + $1,000(0.4224)
$513.42 + $422.40 = $935.82.

With your financial calculator, enter the following:

N = 12; PV = -850; PMT = 0.10 1,000 = 100; FV = 1000; I = YTM = ?
YTM = 12.48%.

9-3

With your financial calculator, enter the following to find YTM:

N = 10 2 = 20; PV = -1100; PMT = 0.08/2 1,000 = 40; FV = 1000; I = YTM = ?
YTM = 3.31% 2 = 6.62%.
With your financial calculator, enter the following to find YTC:
N = 5 2 = 10; PV = -1100; PMT = 0.08/2 1,000 = 40; FV = 1050; I = YTC = ?
YTC = 3.24% 2 = 6.49%.

9-4

With your financial calculator, enter the following to find the current
value of the bonds, so you can then calculate their current yield:
N = 7; I = YTM = 8; PMT = 0.09 1,000 = 90; FV = 1000; PV = VB = ?
PV = $1,052.06. Current yield = $90/$1,052.06 = 8.55%.
Alternatively,
VB =
=
=
=

$90(PVIFA8%,7) + $1,000(PVIF8%,7)
$90((1- 1/1.087)/0.08) + $1,000(1/1.087)
$90(5.2064) + $1,000(0.5835)
$468.58 + $583.50 = $1,052.08.

Current yield = $90/$1,052.08 = 8.55%.

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Answers and Solutions: 9 - 1

9-5

The problem asks you to find the price of a bond, given the following
facts:
N = 16; I = 8.5/2 = 4.25; PMT = 45; FV = 1000.
With a financial calculator, solve for PV = $1,028.60

9-6

a. VB = PMT(PVIFAi,n) + FV(PVIFi,n)
= PMT((1- 1/(1+in))/i) + FV(1/(1+i)n)
1. 5%:

Bond L:
Bond S:

VB = $100(10.3797) + $1,000(0.4810) = $1,518.97.

VB = ($100 + $1,000)(0.9524) = $1,047.64.

2. 8%:

Bond L:
Bond S:

VB = $100(8.5595) + $1,000(0.3152) = $1,171.15.

VB = ($100 + $1,000)(0.9259) = $1,018.49.

3. 12%:

Bond L:
Bond S:

VB = $100(6.8109) + $1,000(0.1827) = $863.79.

VB = ($100 + $1,000)(0.8929) = $982.19.

Calculator solutions:
1. 5%:

Bond L:
Bond S:

2. 8%:

Bond L:
Bond S:

3. 12%:

Bond L:
Bond S:

Input N = 15, I = 5, PMT = 100, FV = 1000, PV = ?,

PV = $1,518.98.
Change N = 1, PV = ? PV = $1,047.62.
From Bond S inputs, change N = 15 and I = 8, PV
= ?, PV = $1,171.19.
Change N = 1, PV = ? PV = $1,018.52.
From Bond S inputs, change N = 15 and I = 12,
PV = ? PV = $863.78.
Change N = 1, PV = ? PV = $982.14.

b. Think about a bond that matures in one month. Its present value is
influenced primarily by the maturity value, which will be received in
only one month. Even if interest rates double, the price of the bond
will still be close to $1,000.
A one-year bond's value would
fluctuate more than the one-month bond's value because of the
difference in the timing of receipts. However, its value would still
be fairly close to $1,000 even if interest rates doubled. A longterm bond paying semiannual coupons, on the other hand, will be
dominated by distant receipts, receipts which are multiplied by 1/(1
+ kd/2)t, and if kd increases, these multipliers will decrease
significantly.
Another way to view this problem is from an
opportunity point of view. A one-month bond can be reinvested at the
new rate very quickly, and hence the opportunity to invest at this
new rate is not lost; however, the long-term bond locks in subnormal
returns for a long period of time.

Answers and Solutions: 9 - 2

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

INT
M
+
t = 1 (1 + k )t (1 + k )N
d
d
N

9-7

a. VB =

INT(PVIFAk ,N) + M(PVIFk ,N)

d

= PMT((1- 1/(1+kdn))/kd) + FV(1/(1+kd)n).

= $1,000. INT = 0.09($1,000) = $90.

1. $829 = $90(PVIFAkd ,4) + $1,000(PVIFk d ,4)

$829= $90((1- 1/(1+kd4))/kd) + $1,000(1/(1+kd)4).
The YTM can be found by trial-and-error.
If the YTM was 9
percent, the bond value would be its maturity value.
Since the
bond sells at a discount, the YTM must be greater than 9 percent.
Let's try 10 percent.
At 10%, VB = $90(3.1699) + $1,000(0.6830) = $285.29 + $683.00
= $968.29.
$968.29 > $829.00; therefore, the bond's YTM is greater than 10
percent.
Try 15 percent.
At 15%, VB = $90(2.8550) + $1,000(0.5718) = $256.95 + $571.80
= $828.75.
Therefore, the bond's YTM is approximately 15 percent.
2. $1,104 =

$90(PVIFAk ,4) + $1,000(PVIFk ,4).

d

The bond is selling at a premium; therefore, the YTM must be below

9 percent. Try 6 percent.
At 6%, VB = $90(3.4651) + $1,000(0.7921) = $311.86 + $792.10
= $1,103.96.
Therefore, when the bond
approximately 6 percent.

is

selling

for

$1,104,

its

YTM

is

Calculator solution:
1. Input N = 4, PV = -829, PMT = 90, FV = 1000, I = ? I = 14.99%.
2. Change PV = -1104, I = ?

I = 6.00%.

b. Yes.
At a price of $829, the yield to maturity, 15 percent, is
greater than your required rate of return of 12 percent.
If your
required rate of return were 12 percent, you should be willing to buy
the bond at any price below $908.86 (using the tables) and $908.88
(using a calculator).

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Answers and Solutions: 9 - 3

9-8

$1,000 = $140(PVIFAkd ,6) + $1,090(PVIFkd ,6)

$1,000 = $140((1- 1/(1+kd6))/kd) + $1,090(1/(1+kd)6).
Try 18 percent:
PV18% = $140(3.4976) + $1,090(0.3704) = $489.66 + $403.74 = $893.40.
18 percent is too high.
Try 15 percent:
PV15% = $140(3.7845) + $1,090(0.4323) = $529.83 + $471.21 = $1,001.04.
15 percent is slightly low.
The rate of return is approximately
calculator using the following inputs.

15.03

N = 6; PV = -1000; PMT = 140; FV = 1090; I = ?

9-8

a. $1,100 =

$60(PVIFAk

) + $1,000(PVIFk

/ 2,20

percent,

found

with

Solve for I = 15.03%.

).

/ 2,20

Using a financial calculator, input the following:

N = 20, PV = -1100, PMT = 60, FV = 1000, and solve for I = 5.1849%.
However, this is a periodic rate.
5.1849%(2) = 10.3699% 10.37%.

The

nominal

annual

rate

b. The current yield = $120/$1,100 = 10.91%.

c.

YTM = Current Yield + Capital Gains (Loss) Yield

10.37% = 10.91% + Capital Loss Yield
-0.54% = Capital Loss Yield.

d. $1,100 =

$60(PVIFAk

) + $1,060(PVIFk

/ 2,8

).

/ 2,8

Using a financial calculator, input the following:

N = 8, PV = -1100, PMT = 60, FV = 1060, and solve for I = 5.0748%.
However, this is a periodic rate.
5.0748%(2) = 10.1495% 10.15%.
9-10

The

nominal

annual

rate

The problem asks you to solve for the YTM, given the following facts:
N = 5, PMT = 80, and FV = 1000.

In order to solve for I we need PV.

However, you are also given that the current yield is equal to 8.21%.
Given this information, we can find PV.
Answers and Solutions: 9 - 4

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Current yield = Annual interest/Current price

0.0821 = $80/PV
PV = $80/0.0821 = $974.42.
Now, solve for the YTM with a financial calculator:
N = 5, PV = -974.42, PMT = 80, and FV = 1000.
8.65%.
9-11

Solve for I = YTM =

The problem asks you to solve for the current yield, given the following
facts: N = 14, I = 10.5883/2 = 5.2942, PV = -1020, and FV = 1000. In
order to solve for the current yield we need to find PMT.
With a
financial calculator, we find PMT = $55.00. However, because the bond
is a semiannual coupon bond this amount needs to be multiplied by 2 to
obtain the annual interest payment: $55.00(2) = $110.00. Finally, find
the current yield as follows:
Current yield = Annual interest/Current Price = $110/$1,020 = 10.78%.

9-12

The bond is selling at a large premium, which means that its coupon rate
is much higher than the going rate of interest. Therefore, the bond is
likely to be called--it is more likely to be called than to remain
outstanding until it matures. Thus, it will probably provide a return
equal to the YTC rather than the YTM.
So, there is no point in
calculating the YTM--just calculate the YTC. Enter these values:
N = 10, PV = -1353.54, PMT = 70, FV = 1050, and then solve for I.
The periodic rate is 3.24 percent, so the nominal YTC is 2 x 3.24% =
6.47%. This would be close to the going rate, and it is about what the
firm would have to pay on new bonds.

9-13

a. The bonds now have an 8-year, or a 16-semiannual period, maturity,

and their value is calculated as follows:

$50
$1,000
+
t = 1 (1.03 )t (1.03 )16
16

VB =

= $50(12.5611) + $1,000(0.6232)

= $628.06 + $623.20 = $1,251.26.

Calculator solution: Input N = 16, I = 3, PMT = 50, FV = 1000,
PV = ? PV = $1,251.22.
b. VB = $50(10.1059) + $1,000(0.3936) = $505.30 + $393.60 = $898.90.

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Answers and Solutions: 9 - 5

Calculator solution:
PV = $898.94.

Change inputs from Part a to I = 6, PV = ?

c. The price of the bond will decline toward $1,000, hitting $1,000
(plus accrued interest) at the maturity date 8 years (16 six-month
periods) hence.
9-14

The answer depends on when one works the problem.

1998, Wall Street Journal:

We used the June 2,

a. AT&T's 8.625%, 2031 bonds had a 7.9 percent current yield. The bonds
sold at a premium, 109.875% of par, so the coupon interest rate would
have to be set lower than 8.625% for the bonds to sell at par. If we
assume the bonds arent callable, we can do a rough calculation of
their YTM.
Using a financial calculator, we input the following
values: N = 34 x 2 = 68, PV = 1.09875 x -1,000 = -1098.75, PMT =
0.8625/2 x 1,000 = 86.25/2 = 43.125, FV = 1000, and then solve for
YTM = kd = 3.8968% x 2 = 7.79% 7.8%.
Thus, AT&T would have to set a rate of 7.8 percent on new longterm bonds.
b. The return on AT&T's bonds is the current yield of 7.9 percent, less
a small capital loss in 2031. The total return is about 7.8 percent.
9-15

a. The original yield to maturity was 3.4 percent. This can be demonstrated by showing that a value of 3.4 percent for k d solves this
equation:

$34
$1,000
+
t = 1 (1 + k )t (1 + k )30 .
d
d
30

$1,000 =

Calculator solution:
I = ? I = 3.40%.

Input N = 30, PV = -1000, PMT = 34, FV = 1000,

b. In February 1985, the bond had a remaining life of 17 years.

its value is calculated as follows:

Thus,

$34
$1,000
+
t = 1 (1 + k )t (1 + k )17
d
d
17

VB = $650 =

$34(PVIFAk ,17) + $1,000(PVIFk ,17).

d

Trying PVIFA and PVIF for 7 percent, we obtain the following:

VB = $34(9.7632) + $1,000(0.3166) = $648.55 $650.
Answers and Solutions: 9 - 6

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Therefore, kd 7%.
Solving for kd using a financial calculator gives 6.98 percent.
Input N = 17, PV = -650, PMT = 34, FV = 1000, I = ? I = 6.98%.
c. In February 2000, the bonds have a remaining life of 2 years.
their value is calculated as follows:

$34 $1,000
t = 1 (1.07 )t + (1.07 )2

Thus,

VB =

Calculator solution:
PV = $934.91.

= $934.91.

Input N = 2, I = 7, PMT = 34, FV = 1000, PV = ?

d. Just before maturity, the bond has a value of $1,000 (plus accrued
interest, which should not concern students at this point).
e. The price of the bonds will rise. There is a built-in capital gain;
thus, for discount bonds kd = Interest yield + Capital gains yield.
Of course, if interest rates rise, part of this built-in gain can be
offset for holding periods less than the years to maturity.
f. 1. In February 1985 the current yield = $34/$650 = 5.23%.
2. In February 2000 the current yield = $34/$934.91 = 3.64%.
kd = Total yield = Capital gains yield + Current yield.
Here kd = 7% as solved in Part b of the problem, so the capital
gains yield in February 1982 was 7.0% - 5.23% = 1.77%, and the
capital gains yield in February 1997 was 7.0% - 3.64% = 3.36%.
Alternatively, the capital gains yield could have been calculated
by finding the price with 16 years and 1 year remaining and using
the formula:

B1 - VB0
V
.
VB0
In February 1985 the capital gains yield = ($661.51 - $650)/$650 =
1.77%.
In February 2000 the capital gains yield = ($966.36 - $934.91)/
$934.91 = 3.36%.
The total yield at both dates was 7 percent.

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Answers and Solutions: 9 - 7

9-16

a. Yield to maturity (YTM):

With a financial calculator, input N = 28, PV = -1165.75, PMT = 95,
FV = 1000, I = ? I = kd = YTM = 8.00%. With the formulas, proceed
as follows:
$1,165.75 =

$95(PVIFAk ,28) + $1,000(PVIFk ,28)

= $95((1-

1/(1+kd28))/kd) + $1,000(1/(1+kd)28).

Try 10 percent:
Is $1,165.75 = $95(PVIFA10%,28) + $1,000(PVIF10%,28)?
= $95(9.3066) + $1,000(0.0693) = $953.43 < $1,165.75.
Try 9 percent:
Is $1,165.75 = $95(PVIFA9%,28) + $1,000(PVIF9%,28)?
= $95(10.1161) + $1,000(0.0895) = $1,050.53 < $1,165.75.
Try 8 percent:
Is $1,165.75 = $95(PVIFA8%,28) + $1,000(PVIF8%,28)?
= $95(11.0511) + $1,000(0.1159) = $1,165.75 = $1,165.75.
Therefore, YTM = 8%.
Yield to call (YTC):
With a calculator, input N = 3, PV = -1165.75, PMT = 95, FV = 1090,
I = ? I = kd = YTC = 6.11%. With the formulas, proceed as follows:
$1,165.75 = $95(PVIFAkd ,3) + $1,090(PVIFkd ,3)
= $95((1- 1/(1+k d28))/kd) + $1,090(1/
(1+kd)28).
Try 7 percent:
Is $1,165.75 = $95(PVIFA7%,3) + $1,090(PVIF7%,3)?
= $95(2.6243) + $1,090(0.8163) = $1,139.08 < $1,165.75.
Try 6 percent:
Is $1,165.75 = $95(PVIFA6%,3) + $1,090(PVIF6%,3)?
= $95(2.6730) + $1,090(0.8396) = $1,169.10 > $1,165.75.
Try 6.1 percent:
Is $1,165.75 = $95(PVIFA6.1%,3) + $1,090(PVIF6.1%,3)?
= $95(2.6681) + $1,090(0.8372) = $1,166.02 $1,165.75.
Therefore, YTC 6.1%.
Answers and Solutions: 9 - 8

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

b. Knowledgeable investors would expect the return to be closer to 6.1

percent than to 8 percent. If interest rates remain substantially
lower than 9.5 percent, the company can be expected to call the issue
10-year, 10% annual coupon
10-year zero
5-year zero
30-year zero
$100 perpetuity

Price at 8%
$1,134.20
463.19
680.58
99.38
1,250.00

Price at 7%
$1,210.71
508.35
712.99
131.37
1,428.57

Pctge. change
6.75%
9.75
4.76
32.19
14.29

at the call date and to refund it with an issue having a coupon rate
lower than 9.5 percent.
c. If the bond had sold at a discount, this would imply that current
interest rates are above the coupon rate.
Therefore, the company
would not call the bonds, so the YTM would be more relevant than the
YTC.
9-17

9-18

a.
t
0
1
2
3
4

Price of Bond C
$1,012.79
1,010.02
1,006.98
1,003.65
1,000.00

Price of Bond Z
$ 693.04
759.57
832.49
912.41
1,000.00

b.

Bond

Value
($)
1,100
1,000

Time

Bond

Path

900

Bond

800

Answers and Solutions: 9 - 9

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

700
0

Years

Answers and Solutions: 9 - 10

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

SOLUTION TO SPREADSHEET PROBLEMS

9-19 The detailed solution for the problem is available both on the
instructors resource CD-ROM (in the file Solution for Ch 09-19 Build a
Model.xls) and on the instructors side of the Harcourt College
Publishers web site, http://www.harcourtcollege.com/finance/theory10e.
9-20

a. The price of the bond has risen to $1,200 which is higher than the
2002 price, so interest rates must have fallen below their 2002
level.
Since interest rates have fallen, an investor should expect to
receive the yield to call and would price the bond so that the YTC
provided him or her with the current market required return. In this
case, the YTC is approximately 3.41 percent, so the YTC has fallen
from 6.1 percent in 2002 to 3.41 percent in 2003.
INPUT DATA:
Bond's par value
Coupon rate
Call price
Current bond price

$1,000.00
9.50%
109%
$1,200.00

KEY OUTPUT:
Yield to maturity:
Yield to call:

7.72%
3.41%

Original Maturity
Years remaining
Years until callable

30
27
2

b. Since the price of the bond has fallen to $800, interest rates must
have risen sharply. In this case, the bond will not be called, so
investors should expect to receive the 12.02 percent yield to
maturity.
INPUT DATA:
Bond's par value
Coupon rate
Call price
Current bond price

$1,000.00
9.50%
109%
$800.00

KEY OUTPUT:
Yield to maturity:
Yield to call:

12.02%
27.79%

Original Maturity
Years remaining
Years until callable

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

30
27
2

Solution to Cyberproblem: 9 - 11

Mini Case: 9 - 12

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.