Running head: VALUATION OF BONDS 1

Valuation of Bonds Assessment 6

Brandon Yaghjian-Tison

Capella University
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1. Explain what a call provision enables bond issuers to do. Why would bond issuers exercise

a call provision?

According to Investopedia a call provision is “a provision on a bond or other fixed-income

instrument that allows the original issuer to repurchase and retire the bonds” (Investopedia,

2016). A bond issuer would typically exercise a call provision in the event that interest

rates within the market drop within the timeframe of the call date. This would allow the

bond issuer to refinance their debt at a lower interest rate, and thus a lower repayment rate.

2. Define a discount bond and a premium bond. Provide examples of each.

Discount Bond - “A premium bond is a bond trading above its par value; a bond trades at a

premium when it offers a coupon rate higher than prevailing interest rates” (Investopedia, 2015).

Example: An investor purchases a bond at face value or par value, for $5,000.00.

However, due to market value, the bond’s value decreases to $4,500.00. The investor

would then trade this bond at a lower rate than the original par value.

Premium Bond - “A premium bond is a bond trading above its par value; a bond trades at a

premium when it offers a coupon rate higher than prevailing interest rates” (Investopedia, 2015).

Example: Unlike a Discount Bond, if an investor purchases a bond at face value or par

value of $4,500.00, but due to the market value the value of the bond increases to

$5,000.00, the investor would be able to trade the bond at a higher than face value amount.

3. Describe the relationship between interest rates and bond prices.

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There is an unlikely relationship between interest rates and bond prices. They have an inverse

relationship, meaning as bond prices decrease, interest rates increase, and the reverse for each.

They have opposite moving relationships. At first glance this inverse relationship may seem odd,

but to make it clearer one must consider “zero-coupon bonds, which don't pay coupons but

derive their value from the difference between the purchase price and the par value paid

at maturity”(Investopedia, 2016).

4. Describe the differences between a coupon bond and a zero coupon bond

There are several differences between a coupon bond and a zero coupon bond. To start, a zero

coupon bond gain profits from the difference between the purchase price and the face value

price. A standard coupon bond, on the other hand, gains profits from standard distribution of

interest. Also, a Zero Coupon bond does not pay out of coupons to its bond holders as a standard

coupon bond does, and the bond holder of a zero coupon bond will only receive the face value of

their bond at maturity versus a coupon bond holder who will receive the face value plus the paid

coupons through the lifespan of the bond. (Langager, 2006)

Part II

1. Assuming semi-annual compounding, what is the price of a zero coupon bond that matures

in 3 years if the market interest rate is 5.5 percent? Assume par value is $1000.

Interest Rate per semiannual= R=5.5%/2=2.75%

Number of periods=N=3*3=9
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Par Value of bond =±V = $1,000

Price of Bond = V/(1+R)/\N = $849.78

Price of Bond = $849.78

2. Using semi-annual compounding, what is the price of a 5 percent coupon bond with 10

years left to maturity and a market interest rate of 7.2 percent? Assume that interest

payments are paid semi-annually and that par value is $1000.

Par value of bond = ±V = $1,000

Coupon = PMT = 1000*5%/2=$25.00

Number of coupons = NPER = 10*2=20

Market Interest rate = M=7.2%/2 = 3.60%

Price = $845.07

3. Using semi-annual compounding, what is the yield to maturity on a 4.65 percent coupon

bond with 18 years left to maturity that is offered for sale at $1,025.95? Assume par value

is $1000.

Par value of bond = ±V = $1,000

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Coupon = 1,000*4.6%/2 = $23.25

Number of Coupons = NPER = 18*2= 36

Price of bond= PV=-$1025.95

Years left to Maturity= YTM= 2.22%

If bond is semi-annual, then annual YTM = 4.44%

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References

Discount Bond. (2015). Retrieved December 02, 2016, from

http://www.investopedia.com/terms/d/discountbond.asp

Premium Bond. (2015). Retrieved December 02, 2016, from

http://www.investopedia.com/terms/p/premiumbond.asp

Why do interest rates tend to have an inverse relationship with bond prices? (2016).

Retrieved December 08, 2016, from

http://www.investopedia.com/ask/answers/04/031904.asp

Langager, C. (2006). What is the difference between a zero-coupon bond and a regular bond?

Retrieved December 08, 2016, from

http://www.investopedia.com/ask/answers/06/zerocouponregularbond.asp