Question

Question 2 (25 marks) Eliza Mok spots two bonds in the market in which she is interested. The first bond is a 20-year bond issued by Orange Ltd two years ago with a coupon rate of 4.9%. The second bond is a 10-year bond issued by Pear Ltd one year ago at a coupon rate of 5.1%. Both bonds have a par value of $1,000 and make semiannual payments a If the yield to maturity (YTM) on the Orange bond is 5.0%, what is the current bond price? (10 marks)

Answer 1

(a)-Current Price of the Bond issued by Orange Ltd

The Price of the Bond is the Present Value of the Coupon Payments plus the Present Value of the Face Value/Par Value. The Price of the Bond is normally calculated either by using EXCEL Functions or by using Financial Calculator.

Here, the calculation of the Bond Price using financial calculator is as follows

Variables	Financial Calculator Keys	Figures
Face Value [-$1,000]	FV	-1,000
Coupon Amount [$1,000 x 4.90% x ½]	PMT	24.50
Market Interest Rate or Required Rate of Return [5.00% x ½]	1/Y	2.50
Time to Maturity [(20 Years – 2 Years) x 2]	N	36
Bond Price	PV	?

Here, we need to set the above key variables into the financial calculator to find out the Price of the Bond. After entering the above keys in the financial calculator, we get the Price of the Bond = $988.22

“The Current Price of the Bond will be $988.22”

(b)-Yield to Maturity (YTM) of the Bond issued by Pear Ltd

The Yield to maturity of (YTM) of the Bond is calculated using financial calculator as follows (Normally, the YTM is calculated either using EXCEL Functions or by using Financial Calculator)

Variables	Financial Calculator Keys	Figure
Face Value [$1,000]	FV	1,000
Coupon Amount [$1,000 x 5.10% x ½]	PMT	25.50
Yield to Maturity [YTM]	1/Y	?
Time to Maturity [(10 Years – 1 Years) x 2]	N	18
Bond Price [-$1,000 x 102%]	PV	-1,020

We need to set the above figures into the financial calculator to find out the Yield to Maturity of the Bond. After entering the above keys in the financial calculator, we get the yield to maturity (YTM) on the bond = 2.41%

The semi-annual Yield to maturity = 2.41%

Therefore, the annual Yield to Maturity of the Bond = 4.82% [2.41% x 2]

“Hence, the Yield to Maturity (YTM) of the Bond will be 4.82%”

Requirement - (c)

-If the coupon rate of a bond is above the current market interest rates, a bond will sell at Premium.

-When pricing bonds, there is an inverse relationship between the Market price and market interest rate or Yield to Maturity of the Bond

-The Market Price of the Bond is the Present Value of the Coupon Payments plus the Present Value of the face Value

-If the Market Interest Rate Increases, then the discounting rate will be higher & the discounting factor will be lower and it will result’s in the Market Price of the Bond to be lower.

-If the Market Interest Rate Decreases, then the discounting rate will be lower & the discounting factor will be higher and it will result’s in the Market Price of the Bond to be higher.

- If the Yield to Maturity [YTM] is greater than the coupon rate, then the selling price of the bond will be less than its par value, since the bonds are selling at discount

- If the Yield to Maturity [YTM] is less than the coupon rate, then the selling price of the bond will be more than its par value, since the bonds are selling at premium.