Question

Hi there! Needing some help with D, E and F (all parts). I need to verify some answers. Thanks for the help!

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Mini Case Sam Strother and Shawna Tibbs are vice presidents of Mutual of Seattle Insurance Company and co- directors of the company's pension fund management division. An important new client, the North- Western Municipal Alliance, has requested that Mutual of Seattle present an investment seminar to the mayors of the represented cities, and Strother and Tibbs, who will make the actual presentation, have asked you to help them by answering the following questions.

Answer 1

d]

Price of a bond is the present value of its cash flows. The cash flows are the coupon payments and the face value receivable on maturity

Price of bond is calculated using financial calculator as below :

I/Y = 10 (required rate of return)

N = 10 (Years remaining until maturity with 1 annual coupon payment each year)

PMT = 100 (annual coupon payment = face value * coupon rate = $1000 * 10% = $100)

fv = 1000 (face value receivable on maturity)

CPT --> PV

PV is calculated to be $1000.00

The price of the bond is $1000.00.

e]

1]

Price of bond is calculated using financial calculator as below :

I/Y = 13 (required rate of return)

N = 10 (Years remaining until maturity with 1 annual coupon payment each year)

PMT = 100 (annual coupon payment = face value * coupon rate = $1000 * 10% = $100)

fv = 1000 (face value receivable on maturity)

CPT --> PV

PV is calculated to be $837.21

The price of the bond is $837.21

This is a discount bond as the price of the bond is lower than its face value.

2]

Price of bond is calculated using financial calculator as below :

I/Y = 7 (required rate of return)

N = 10 (Years remaining until maturity with 1 annual coupon payment each year)

PMT = 100 (annual coupon payment = face value * coupon rate = $1000 * 10% = $100)

fv = 1000 (face value receivable on maturity)

CPT --> PV

PV is calculated to be $1210.71

The price of the bond is $1210.71

This is a premium bond as the price of the bond is higher than its face value.

3]

The price of the bond over time (from 10 years to 0 years until maturity) is calculated using 7% and 13% required return using the financial calculator. The results are as below :

A B C 13% 17% Years to Required Required i Maturity Return Return 10 $837.21 $1,210.71 $846.05 $1,195.46 8 $856.04 $1,179.14 7 $867.32 $1,161.68 6 $880.07 $1,143.00 5 $894.48 $1,123.01 4 $910.77 $1,101.62 3 $929.17 $1,078.73 2 $949.96 $1,054.24 1 $973.45 $1,028.04 12 0 $1,000.00 $1,000.00

Over time, the price of the bond converges to its face value of $1000.

f]

1]

YTM of bond is calculated using financial calculator as below :

PV = -887 (price of bond)

N = 10 (Years remaining until maturity with 1 annual coupon payment each year)

PMT = 100 (annual coupon payment = face value * coupon rate = $1000 * 10% = $100)

fv = 1000 (face value receivable on maturity)

CPT --> I/Y

I/Y is calculated to be 12.00%

YTM of bond is calculated using financial calculator as below :

PV = -1134.20 (price of bond)

N = 10 (Years remaining until maturity with 1 annual coupon payment each year)

PMT = 100 (annual coupon payment = face value * coupon rate = $1000 * 10% = $100)

fv = 1000 (face value receivable on maturity)

CPT --> I/Y

I/Y is calculated to be 8.00%

We can see that the relationship between required return and coupon rate is as below :

• If required return is higher than coupon rate, the bonds sells at a discount
• If required return is lower than coupon rate, the bonds sells at a premium