6.6 Coupon Rate. How does a bond issuer decide on the appropriate coupon rate to set on its bonds? Explain the difference between the coupon rate and the required return on a bond.
Questions and Problems 8.
Bank Bill Prices. Chocolate Fund is buying a 120-day bank bill today. The bill matures in 120 days' time. The bill has a face value of $500,000 and the current market yield on this bill is 5.25% pa. What is the price that Chocolate Fund will have to pay to buy the bill today?
13. Nominal and Real Returns. An investment offers a 14% total return over the coming year. The Reserve Bank thinks the total real return on this investment will be only 9%. What does the Reserve Bank believe the inflation rate will be over the next year?
18. Bond Price Movements.
Bond X is a premium bond making annual payments. The bond pays a 9% coupon, has a YTM of 7%, and has thirteen years to maturity.
Bond Y is a discount bond making annual payments. This bond pays a 7% coupon, has a YTM of 9%, and also has thirteen years to maturity.
Given that the face value is $1,000 for each bond, what are the prices of these bonds today? If interest rates remain unchanged, what do you expect the prices of these bonds to be in one year? In three years? In eight years? In twelve years? In thirteen years? What’s going on here? Illustrate your answers by graphing bond prices versus time to maturity.
19. Interest rate Risk (with Time to Maturity).
Both Bond Bill and Bond Ted have 8% coupons, make half-yearly payments, have a $1,000 face value, and are priced at par value. Bond Bill has three years to maturity, whereas Bond Ted has twenty years to maturity. If interest rates suddenly rise by 2%, what is the percentage change in the price of Bond Bill? Of Bond Ted? If rates were to suddenly fall by 2% instead, what would the percentage change in the price of Bond Bill then? Of Bond Ted? Illustrate your answers by graphing bond prices versus YTM. What does this problem tell you about the interest rate risk of longer-term bonds?
20. Interest rate Risk (With Coupon Rate).
Bond J is a 4% coupon bond. Bond S is a 10% coupon bond. Both bonds have eight years to maturity, $1,000 face value, make half- yearly payments, and have a YTM of 7%. If interest rates suddenly rise by 2%, what is the percentage price change of these bonds? What if rates suddenly fall by 2% instead? What does this problem tell you about the interest rate risk of lower-coupon bonds?
25. Bond Prices versus Yields.
a. What is the relationship between the price of a bond and its YTM?
b. Explain why some bonds sell at a premium over par value while other bonds sell at a discount. What do you know about the relationship between the coupon rate and the YTM for premium bonds? What about for discount bonds? For bonds selling at par value?
Extra Question
1. AMCOR Limited has a corporate bond outstanding with a 7% coupon, semi-annual interest, 15 years to maturity and a face value of $1,000. Similar bonds currently yield 13%. By prior agreement, the company will skip the coupon payments in years 6, 7, and 8, (6 payments in total; the payments at time 6 through to 8.5). These payments will be repaid, without interest, at maturity. What is the corporate bond’s value?