10.

Fixed Income Securities

Study Session 10
SOLUTION 1A
B0 = ₹ 140 × PVAF (13%, 5 years) + ₹ 1,000 × PVF (13%, 5 years)
= ₹ 140 × 3.517 + ₹ 1,000 x 0.543 = ₹ 1,035.4
SOLUTION 1B
Case (i) Required yield rate = 5%
Year Cash Flow ₹ DF (5%) Present Value
₹
1-5 10 4.3295 43.295
5 110 0.7835 86.185
Value of bond 129.48
Case (ii) Required yield rate = 5.1%
Year Cash Flow ₹ DF (5.1%) Present Value
₹
1-5 10 4.3175 43.175
5 110 0.7798 85.778
Value of bond 128.953
Case (iii) Required yield rate = 10%
Year Cash Flow ₹ DF (10%) Present Value ₹
1-5 10 3.7908 37.908
5 110 0.6209 68.299
Value of bond 106.207
Case (iv) Required yield rate = 10.1%

Year Cash Flow ₹ DF (10.1%) Present Value

₹
1-5 10 3.7811 37.811
5 110 0.6181 67.991
Value of bond 105.802
SOLUTION 2A
We know that value of Perpetual Bond (Bo) =
B0 = = = ₹ 900
.

B0 = = = ₹ 1125.
.

B0 = = = ₹ 750.
.

SOLUTION 2B
Computation of current value of John’s portfolio
(i) 10 Nos. Bond A, ₹ 1,000 par value, 9% Bonds maturity 3 years:
Current value of interest on bond A
1-3 years: = ₹ 900 x Cumulative P.V. @ 12% (1-3 years)
= ₹ 900 x 2.402 = 2,162
Add: Current value of amount received on maturity of Bond A = ₹ 10,000 × 0.712
End of 3rd year: ₹ 1,000 × 10 × P.V. @ 12% (3rd year) = 7,120
= 9,282
(ii) 10 Nos. Bond B, ₹ 1,000 par value, 10% Bonds maturity 5 years:
Current value of interest on bond B
 10.2 FIXED INCOME SECURITIES
1-5 years: = ₹ 1,000 × Cumulative P.V. @ 12% (1-5 years)
= ₹ 1,000 x 3.605
= 3,605
Add: Current value of amount received on maturity of Bond B
End of 5th year: ₹ 1,000 x 10 x P.V. @ 12% (5th year)
= ₹ 10,000 x 0.567 = 5,670
= 9,275
(iii) 100 Preference shares C, ₹ 100 par value, 11% coupon = 8,462
%× .× ₹ × , ,
=
% .

(iv) 100 Preference shares D, ₹ 100 par value, 12% coupon = 9,231
%× .×₹ ,
=
% .
Total current value of his portfolio [(i) + (ii) + (iii) + (iv)] = 36,250
SOLUTION 3A
We know that value of a Zero coupon Bond is ( )

=( )
= ₹ 621

SOLUTION 3B
The current market prices of the two bonds may be estimated to be:
Zero coupon Bonds = 100 / (1.06)15 $ 41.73
12% gilt with a semi-annual coupon

Present value of interest payments using PVAF ( 3% , 30) = $ 6 × 19.6004 117.60

Present value of redemption using PVF ( 3%, 30) = $ 100 × 0.4120 41.20
158.80
(i) If interest rates increase by 1%
Zero coupon Bonds = 100/ (1.07) 15 = $ 36.25 a decrease of $ 5.48 i.e 13.1%
12% gilt with a semi-annual coupon
Present value of interest payment using PVAF (3.5%, 30) = $ 6 × 18.3920 110.35
Present value of redemption using PVF ( 3.5% 30) = $ 100 × 0.3563 35.63
145.98
This is a decrease of $ 12.82 or 8.1%
(ii) If interest rates decrease by 1%
Zero coupon bond = 100/ ( 1.05)15 = $ 48.10, an increase of $ 6.37 or 15.3%
12% gilt with a semi-annual coupon
Present value of interest payments using PVAF (2.5% 30) $ 6 × 20.9303 125.58
Present value of redemption using PVF ( 2.5%, 30) = $100 × 0.4767] 47.67
173.25
This is an increase of $ 14.45 or 9.1%
SOLUTION 4A
Semi-annual Discount Rate = = 8%
Semi-annual Coupon Rate = = 7%
Semi-annual period = 6 × 2 = 12 periods
Value of Bond = ( )
+ ( )
+ …….( )
+ ( )
. . . .
= 70x PVAF ( 8%, 12 periods) + 1000 x PVF ( 8%, 12 periods)
= 70x7.536 +1000 x .397 = 527.52+397 = 924.52
SOLUTION 4B
Market Price of Bond = P.V. of Interest + P.V. of Principal
= ₹ 1,394 + ₹ 8,885 = ₹ 10,279
 10.3

SOLUTION 4C
(i) Rate used for discounting shall be yield. Accordingly ZCB shall fetch:
= = ₹ 4,852
( . )
(ii) The day count basis is actual number days / 365. Accordingly annualized yield shall be:
Yield x = = 6.86%
.
Note: Alternatively, it can also computed on 360 days a year.
(iii) Price GOI 2023 would fetch
= ₹ 10.71 PVAF(8%, 10) + ₹ 100 PVF (8%, 10)
= ₹ 10.71 x 6.71 + ₹ 100 x 0.4632
= ₹ 71.86 + ₹ 46.32 = ₹ 118.18
(iv) Price GOI 2018 Bond would fetch:
= ₹ 5 PVAF (4%, 10) + ₹ 100 PVF (4%, 10)
= ₹ 5 x 8.11 + ₹ 100 x 0.6756
= 40.55 + 67.56 = 108.11
SOLUTION 4D
(a) If the current interest rate is 8%, the company will not extent the duration of Bond and the maximum amount
the investor would ready to pay will be:
= £1,000 PVIAF (8%, 6) + £10,000 PVIF (8%, 6)
= £1,000 x 4.623 + £10,000 x 0.630
= £4,623 + £ 6,300
= £ 10,923
(b) If the current interest rate is 12%, the company will extent the duration of Bond. After six years the value of
Bond will be
= £1,000 PVIAF (12%, 6) + £10,000 PVIF (12%, 6)
= £1,000 x 4.111 + £10,000 x 0.507
= £4,111 + £5,070
= £9,181
Thus, potential loss will be £9,181-£10,923=£1,742
SOLUTION 5
The issue price of the debentures will be the sum of present value of interest payments during 7 years of its maturity
and present value of redemption value of debenture.
Years Cash out flow (₹) PVIF @ 16% PV
1 8 .862 6.896
2 8 .743 5.944
3 12 .641 7.692
4 12 .552 6.624
5 15 .476 7.14
6 15 .410 6.15
7 15+105 .354 42.48
82.926
Thus the debentures should be priced at ₹ 82.926
SOLUTION 6
. . . .
Intrinsic Value per Share =( )
+( )
+( )
+( )
+( )
+( )
+( )
+( )
. . . . . . . . . . . . . . . .
= 1070.33
SOLUTION 7
The bond pays a coupon of 6.50% which means annual interest is ₹ 65.
₹
Therefore, the Current Yield is: = = 6.04%
₹ .
 10.4 FIXED INCOME SECURITIES
SOLUTION 8A
(a) By trial and error method: 900 = + +….+ +
( . ) ( . ) ( . ) ( . )
At 9%: NPV = 63.8
At 12%: NPV = -13
Now using IRR technique,
Kd = Lower Rate + × Difference in Rates
= 10% + × ( 12-10) = 11.76%
( )
(b) By Approximation Formula:

Kd = = = 11.58%

SOLUTION 8B
Calculation of Yield

YTM OR Kd = = = 14.18%

SOLUTION 8C
(i) Calculation of Maximum price
Bo = Rs. 11x PVIFA (13%,3) + Rs. 100x PVIF ( 13%3) = Rs. 11x 2.361 + Rs. 100 x 0.693 = Rs. 25.97 + Rs
69.30 = Rs. 95.27
(ii) Calculation of Yield
.
YTM OR Kd = = . = 11.94% or 12%

SOLUTION 9
(a) Market Price of a Bond
Face Value = 1000; Coupon Rate = 12% Coupon rate = 6% (half yearly)
Interest Amount = 1000 × 6% = 60 Life = 5 years No. of Period = 5 × 2 = 10 terms
YTM = 8 + 2 = 10% p.a YTM = 5% (half yearly)
B0 = 60 × PVAF (5%, 10 terms) + 1040 × PVF (5%, 10 terms) = 1102
(b) Current Yield
₹ 60/1050 × 100 × 2 = 11.43%
(c) YTM

YTM = ×

 ×
= 5.65% per half year or 11.3% p.a

(d) Investment Action

B0 > CMP, 1102> 1050, Under Valued. Hence, Buy the Bond
OLUTION 10
Current yield = ( Coupon Interest / Market Price) × 100 = ( 10/110) × 100 = 9.09%
If current yield go up by 1% i.e. 10.09 the market price would be
10.09 = 10/ Market Price × 100 =>Market Price = ₹ 99.11

SOLUTION 11
( )
YTM OR Kd =

(i) (a) cost of Debentures issued at Par:

, , , ,
, , ( . )
, , , , = 7.8%
(b) Cost of debenture issued at 10% discount
, , , ,
, , ( . )
, , , , = 9.71%
 10.5

(c) Cost of debentures issued at 10% Premium

, , , ,
, , ( . ) , ,
Kd = , , , , = = 6.07%
, ,

(ii) Cost of debentures, if brokerage is paid at 2% and debentures are issued at par
, , , ,
, , ( . ) ,
Kd = , , , , = = 8.17%
, ,

SOLUTION 12
Calculation of yield to Maturity (YTM)
YTM =
( )/
After tax coupon = 9 × (1 – .30) = 6.3%
After tax redemption price = 105 – (15 x .10) or ₹ 103.5
After tax capital gain = 103.50 – 90 = ₹ 13.50
. ( . / ) .
YTM = or = 9.30%
( . )/ .

SOLUTION 13
YTC By IRR Technique :
Let YTC be 11%
NPV =( )
+( )
+( )
+ ( )
+ ( )
-102
. . . . .
NPV = PVAF ( 4 years 11% + 110 x PVF ( 4 years 11%)
 NPV = 10x 3.1 +110 x 659 -102
 NPV = 12+ + 72.49-102= 1.49
Let YTC be 12%
NPV =( )
+( )
+( )
+ ( )
+ ( )
-102
. . . . .
 NPV = 10 x PVAF ( 4 years, 12%) + 110 x PVF ( 4 years 12%) -102
 NPV = 10 x 3.037+110x.636-102 > NPV = 30.37 + 69.96-102
 NPV = 1.67
YTC IRR formula will be
= Lower Rate + × Difference in Rates
.
= 11% + × 1 = 11.47% (approx)
. .
YTC by approximation Formula:
( )
YTC = ( ) = 11.32%

Yield to Put (YTP):

YTP by IRR Technique:
Let YTC be 9%
NPV =( )
+ ( )
+( )
+ ( )
+( )
+( )
- 102
. . . . . .
= 8 × PVAF (5years 9% + 105) + 105 × PUF ( 5yrs 9%)
=8 × 3.89 + 105 × .65 -102 => 99.37-102 => 2.63
Let YTC be 8%
NPV =( )
+ ( ) ( )
+ ( )
+( )
+( )
- 102
. . . . . .
= 8 x PVAF ( 5years 8% + 105) PVF ( 5yrs 8%) - 102
= 4 + 105 × .68 -102 => 103.40 - 102 => 1.40 YTP by IRR formula:
= Lower Rate = x Difference in rates
.
= 8% + × 1 = 8.35%
. .
YTP by approximation Formula:
( )
YTP = ( ) = 8.07%
 10.6 FIXED INCOME SECURITIES
SOLUTION 14
Yield to Worst = 7%
SOLUTION 15
Present value of all cash inflows occurred in 5 years period is :
-1000 + ( )
+( )
+( )
-( )
+( )
+ ( )
+( )
+( )
Using Discount Rate 12%
- 1000 + (100 × .893) + ( 100 ×.797) + ( 1200 × .797) – ( 1000 × .797) + ( 70 × .712) + ( 70 × .636 ) + ( 70
× .567) + ( 1000 × .567) = Rs. 29.45
Using Discount Rate 14%
-1000 + (100 × .877) + ( 100 × .769)+ ( 1200 × .769) – ( 1000 × .769) + ( 70 × .675) + ( 70 × .592 ) + ( 70
× .519) + ( 1000 × .519) = - Rs. 37.58
YTM = Lower Rate + × Difference in Rates
.
= 12% + × 2% = 12.88%
. .

SOLUTION 16A
Straight debt value of the bond = + + …….. +
( . ) ( . ) ( . ) ( . )
= 8x 5.650 + 100 x .322 = 45.2 + 32.2 = 77.4
Conservation value of the bond: 3.70 x 20 = 74.00
Note: Face value of debenture is assumed to be 100.
Decision: Since Conversion value is less then Straight Debt Value, Bond should not be covert today .
SOLUTION 16B
If debenture are not converted its value is as under: PVF @ 8% ₹
Interest @ 12% for 5 years 12x 3.993 47.915
Redemption ₹ 100 in 5th year 100x .681 68.1
116.016
Value of Equity shares i.e. conversion value
Market Price Total
₹4 4 × 20 = ₹ 80
₹5 5 × 20 = ₹ 100
₹6 6 × 20 = ₹ 120
Hence, unless the market price is ₹ 6 conversion should not be exercised.
SOLUTION 17
The appropriate discount rate for valuing the bond for Mr. Z is:
R = 9% + 3% + 2% = 14%
Time CF PVIF 14% PV (CF) PV (CF)
1 150 0.877 131.55
2 150 0.769 115.35
3 150 0.675 101.25
4 150 0.592 88.8
5 1150 0.519 596.85
∑PV (CF) i.e. P0 = 1033.8
Since, the current market value is less than the intrinsic value; Mr. Z should buy the bond. Current yield = Annual
Interest / Price = 150 / 1025.86 = 14.62%
The YTM of the bond is calculated as follows:
@15%
P = 150 × PVIFA 15%, 4 + 1150 × PVIF 15%, 5
= 150 × 2.855 + 1150 × 0.497 = 428.25 + 571.55 = 999.80
@14%
As found in sub part (a) P0 = 1033.80
By interpolation we get,
. .
= 14% + ×(15% - 14%) =14% + % = YTM = 14.23%
. ( . )
 10.7

SOLUTION 18
Interest Strip = 12x PVAF ( 10%, 5 years) = 12x 3.791 = 45.49
Principal Strip = 125xPVF ( 10%, 5 years) = 12x.621 = 77.63
SOLUTION 19
If Kd is 12% B0 = 120 × 5.650 + 1000 × .322 1000
If Kd is 10% B0 = 120 × 6.145 + 1000 ×.386 1123.4
If Kd is 14% B0 = 120 × 5.216 + 1000 ×.270 895.92
Conclusion :
If Kd = Coupon Rate Bond is selling at Face value
If Kd > Coupon Rate Bond is selling at Discount.
If Kd < Coupon Rate Bond has a Premium value.
SOLUTION 20A
Ex-interest price = £81- £ 7 = £ 74;
After –tax interest payments = £ 7 x ( 1-.35) = £ 4.55
£ . £ . £ . £
Now, £ 74 = ( )
+ ( )
+…( )
+( )
. . . .
By IRR Technique :
Trying 8% : ( £74) + £ 4.55 x PVAF ( 8%, 8 year ) + £ 100 x PVAF ( 8%, 8 year ) = 6.18
Trying 10%: (£ 74) + £ 4.55 x PVAF ( 10%, 8 year ) + £ 100 x PVAF(10%, 8 year ) = ( 3.08)
By Interporatin:
Kd = YTC = Lower Rate + x Diff. in rate
.
= 8% + × 2 = 9.3%
. .
By approxmiation Formula :
.
= = 8.96%

SOLUTION 20C
Since the bonds were sold at par, the original YTM was 10%.
₹
YTM = = = 10%
₹
Price of the bond as on 1st July, 2018 =₹ 50 x 9.712 + ₹ 1,000 х 0.417
=₹ 485.60 + ₹ 417
=₹ 902.60
Total value of the bond on the next =₹ 902.60 +₹50 interest date= ₹952.60
Value of bond at purchase date = ₹ 952.60 х
( . ) /
= ₹ 952.60 х 0.9620 (by using excel)
= ₹ 916.40†
The amount to be paid to complete the transaction is ₹916.40. Out of this amount ₹ 16.67 represent accrued
interest* and ₹899.73 represent the bond basic value.
† Alternatively, it can also be calculated as follows:
= ₹ 952.60 х
. ×

= ₹ 952.60 x ( )
.
= ₹ 915.96
The amount to be paid to complete the transaction is ₹915.96. Out of this amount ₹ 16.67 represent accrued
interest* and ₹899.29 represent the bond basic value.
* Accrued Interest can also be calculated as follows:
Accrued Interest on Bonds = 1,000 x x = 16.67

SOLUTION 21
B0 = ( )
+( )
+ ( )
+( )
+ ( )
+( )
= ₹ 1000
. . . . . .
B0 = ( )
+( )
+ ( )
+( )
+ ( )
+( )
= ₹ 1084.25
. . . . . .
 10.8 FIXED INCOME SECURITIES

B0 = ( )
+( )
+ ( )
+( )
+ ( )
+( )
= ₹ 924.18
. . . . . .
The answer shows the inverse relationship that exists between the price of a bond and its rate of return.
.
From 8% to 6% the percentage change in value is = 8.425%
.
From 8% to 10% the percentage change in value is = - 7.582%

SOLUTION 22
Current price (B0) = Interest × PVAF ( 8%, 3 years) + MV× PVF ( 8%, 3 year )
= ₹ 70 × 2.577 + ₹ 1,000 × 0.794 = 974.39
After one year (B1) = Interest × PVAF (8%, 2 years) + MV × PFV (8%, 2 year)
= ₹ 70 × 1.783 + ₹ 1,000 × 0.857 = ₹ 981.81
After two year (B2) = (interest + MV) × PVF ( 8%, 1 year)
= (70 + 1,000) × 0.926 = ₹ 990.82
SOLUTION 23
Value of Par Bond A [ Coupon Rate ( 10% = Yield Rate ( 10%) ]
Life remaining 5 years = 10 × 3.790 + 100 × .621 =₹ 100 = B0
Life remaining 4 years = 10 × 3.17 + 100 × .683 =₹ 100 = B1
Life remaining 3 years = 10 × 2.49 + 100 × .751 =₹ 100 = B2
Life remaining 2 years = 10 × 1.74 + 100 × .826 =₹ 100 = B3
Life remaining 1 years = 10 × .91 + 100 × .909 =₹ 100 = B4
Life remaining 0 years = 0 × 1.00 + 100 × 1.00 =₹ 100 = B5
Value of Premium Bond B [ Coupon Rate ( 12%) > Yield Rate ( 10% ) ]
Life remaining 5 years = 12 × 3.790 + 100 × .621 =₹ 107.58 = B0
Life remaining 4 years = 12 × 3.17 + 100 × .683 =₹ 106.34 = B1
Life remaining 3 years = 12 × 2.49 + 100 × .751 =₹ 104.98 = B2
Life remaining 2 years = 12 × 1.74 + 100 × .826 =₹ 103.48 = B3
Life remaining 1 years = 12 × .91 + 100 × .909 =₹ 101.82 = B4
Life remaining 0 years = 0 × 1.00 + 100 × 1.00 =₹ 100 = B5
Value of Discount Bond C [ Coupon Rate ( 8%) < Yield Rate ( 10% ) ]
Life remaining 5 years = 8 × 3.790 + 100 × .621 = ₹ 92.42 = B0
Life remaining 4 years = 8 × 3.17 + 100 × .683 = ₹ 93.66 = B1
Life remaining 3 years = 8 × 2.49 + 100 × .751 = ₹ 95.02 = B2
Life remaining 2 years = 8 × 1.74 + 100 × .826 = ₹ 96.52 = B3
Life remaining 1 years = 8 × .91 + 100 × .909 = ₹ 98.18 = B4
Life remaining 0 years = 0 × 1.00 + 100 × 1.00 = ₹ 100 = B5
SOLUTION 24
(i) Series X
B0 = ( )
+( )
+ --------------------- + ( )
+ ( )
= ₹ 8,938
. . . .
Series Y
B0 = ( )
+( )
+ --------------------- + ( )
+ ( )
= ₹ 10,000
. . . .
(ii) Series X
B0 = ( )
+( )
+ --------------------- + ( )
+ ( )
= ₹10,597
. . . .
Series Y
B0 = ( )
+( )
+ --------------------- + ( )
+ ( )
= ₹10,000
. . . .
(iii) From above prices it can be conclude that price of Bond- Series X moves inversely with change in interest rate
.i.e. when interest rate rises, bond value decreases and vice-versa
Whereas the price of the Bond – Series Y doesn’t fluctuate, reason being its interest (coupon) adjusted
according to change in Interest Rate.
SOLUTION 25A
We know that, duration of the Bond
= 1× +2× +⋯× + ⋯n
( ) ( ) ( ) ( )
 10.9

= 1× +2× +⋯6 + 6×
. ( . ) ( . ) ( . ) ( )

= [15 × .847 + 30 ×.718 + 45 × .608 + 60 × .515 + 75 × .437 + 90 × .370 + 600 × .370]

.
.
= = 4.25 years
.

SOLUTION 25B
To calculate duration of bond we need YTM, which shall be calculated as follows:
Let us try NPV of Bond @ 5%

,
=( )
+ ( )
+( )
+( )
+( )
– 10,796.80
. . . . .

= ₹ 571.43 + ₹ 544.22 + ₹ 518.30 + ₹ 493.62 + ₹ 8,305.38 – ₹ 10,796.80 = – ₹ 363.85

Let us now try NPV @ 4%
,
=( )
+ ( )
+( )
+( )
+( )
– 10,796.80
. . . . .

= ₹ 576.92 + ₹ 554.73 + ₹ 533.40 + ₹ 512.88 + ₹ 712.43 – ₹ 10,796.80 = ₹ 93.56

Let us now interpolation formula
.
= 4% + ×(5% - 4%)
. ( . )

Duration of X Ltd.’ s Bond

Year Cash flow P.V. @ 4.2% Proportion of Proportion of bond value
bond value x time (years)
1 575.82 600 0.9597 0.0533 0.0533
2 552.60 600 0.9210 0.0512 0.1024
3 530.34 600 0.8839 0.0491 0.1473
4 508.98 600 0.8483 0.0472 0.1888
5 10600
8,629.46 0.8141 0.7992 3.9960
10,797.20 1.0000 4.4878
Duration of the Bond is 4.4878 years say 4.49 years.
Duration of Y Ltd.’s Bond
Year Cash flow P.V. @ 4.2% Proportion of Proportion of bond value
bond value x time (years)
1 383.88400 0.9597 0.0387 0.0387
2 368.40400 0.9210 0.0372 0.0744
3 353.56400 0.8839 0.0357 0.1071
4 339.32400 0.8483 0.0342 0.1368
5 10400
8,466.64 0.8141 0.8542 4.2710
9,911.80 1.0000 4.6280
Duration of the Bond is 4.6280 years say 4.63 years.
Decision: Since the duration of Bond of X Ltd. is lower and also carrying higher interest rate hence it should be
preferred.
SOLUTION 25C
Value of Bond B0 = C × 1,00,000 × PVAF ( 16%, 6 years ) + 1,00,000 × PVF ( 16%, 6 years)
B0 = C × 1,00,000 × 3.685 + 1,00,000 × .410
B0 = 3,68,500C + 41,000…(i)
Also, we have Duration of Bond =
× , , × , , × , , × , , × , , × , ,
4.3202 = [1× +2× +3× +4× +5× +6× +6×
( . ) ( . ) ( . ) ( . ) ( . ) ( . )
, ,
]
( . )

4.3202 = [86200C + 148600C +192300C+ 220800C + 238000C + 246000C +246000]

 10.10 FIXED INCOME SECURITIES

4.3202 = [11,31,900C+246000]
 3202 B0 =11,31900C + 2,46,000
B0 = 262002C+56942…… (ii)
From (i) and (ii) we have
368500C+41000=262002C+56942 =>368500 - 262002C =>56942 - 41000
 106498C =15942 => C=15% (approx)
Therefore B0 = .15 × 368500 + 41000 =₹ 96275
SOLUTION 26
We know that value of a Zero coupon Bonds is = = 621
( ) ( . )
Duration of bond =
1 × ( )
+2×( )
…. n × ( )
+n× ( )

1 × ( )
+2×( )
…. 5 × ( )
+5× ( )
. . . .
= 5 years
SOLUTION 27
(a) If the yield of the bond falls the price will always increase.
This can be shown by following calculation.
If YIELD FALLS TO 6%
Price OF 5 Years bond :
B0 = ₹ 80 × PVF ( 6%, 5 years) + ₹ 1000 × PVF ( 6%, 5 years)
= ₹ 80 × (4.212) + ₹ 1000 × (0.747) = ₹ 336.96 + ₹ 747 = ₹ 1,083.96
Increase in 5 years’ bond price = ₹ 1083.96 – ₹ 1000= ₹ 83.96
Price of 20 year bond :
Bo = ₹ 80 × PVAF (6%, 20) + ₹ 1,000 × PVF ( 6%, 20)
= ₹ 80 × 11.47 + ₹ 1,000 × 0.312 = ₹ 917.60 + ₹ 312.00 = ₹ 1229.60
So increase in bond price is ₹ 1229.60 - ₹ 1000 = ₹ 229.60
Price Increase Due to Change IN Present Value of Principal 5 years bond
Change in price due to change in Present Value of Principal
= ₹ 1,000 × PVF (6%, 5) – ₹ 1,000 × PVF ( 8%, 5)
= ₹ 1,000 × 0.747 - ₹ 1,000 × 0.681 = ₹ 747.00 - ₹ 681.00 = ₹ 66.00
Therefore % change in price due to change in Present Value of Principal
= (₹ 66/ ₹ 83.96) × 100 = 78.6%
20 yrs Bond
Change in price due to change in Present Value of Principal
= ₹ 1,000 × PVF (6%, 20) – ₹ 1,000 × PVF ( 8%, 20)
= ₹ 1,000 × 0.312- ₹ 1,000 × 0.214= ₹ 312.00 – ₹ 214.00 = ₹ 98.00
Therefore % change in price due to change in present value of Principal
= (₹ 98/ ₹ 229.60) × 100 = 42.68%
Prince Increase Due to Change In Present Value of Interest
5 years Bond:
₹ 80 × PVAF (6%, 5) – ₹ 80 × PVAF ( 8%,5)
= ₹ 80 × 4.212 – ₹ 80 × 3.993= ₹ 336.96 - ₹ 319.44 = ₹ 17.52 or [83.96 - 66]
Therefore % change in price due to change in Present Value of Interest
= (₹ 17.52/83.96) × 100 = 20.86%
20 years Bond :
₹ 80 × PVAF (6%, 20) – ₹ 80 × PVAF (8%, 20) = ₹ 80 × 11.47 - ₹ 80 × 9.82 = ₹ 917.60 - ₹ 785.60 = ₹ 132
or [229.60 - 98]
Therefore % change in price due to change in Present value of Interest
= (₹ 132/₹ 229.60) × 100 = 57.49%
(b) Duration is the average time taken to recollect back the investment
= 1 × ( )
+2 × ( )
….n × ( )
+ n × ( )
 10.11

= 1 × ( )
+2 × ( )
….6 × ( )
+ 6 × ( )
. . . .
= 5.098 Years
(c) If YTM goes up to 10%, current price of the bond will decrease to
₹ 70 × PVAF (10%, 6) + ₹ 1000 × PVF (10%, 6) = ₹ 304. 85+ ₹ 564.00 => ₹ 868.85
New Duration
= 1 × ( )
+2×( )
…. 6 × ( )
+6×( )
. . . . .
= 5.025 years
The duration of bond decreases, reason being the receipt of slightly higher portion of one’s investment of the
same intervals.
[ In other words The Duration of Bond Decreases If YTM goes upto 10% This is because if YTM goes up Bond
value ( Initial Investment) will decrease and we know that lower the Bond Value more quickly will be the
recovery and hence lower the duration ]
(d) Duration is nothing but the average time taken by an investor to collect his/ her investment. If an investor
receives a part of his/ her investment over the time on specific intervals before maturity, the investment will
offer him the duration which would be lesser than the maturity of the instrument. Higher the coupon rate,
lesser would be the duration. In other words Duration of a bond will always be less than the time to maturity.
This is because Maturity is the total life of Bond but Duration is the weighted average time period by which
bond value is fully recovered. No investor will invest in such bond where duration is more than maturity.
Hence it should always be less than or equal to maturity.
SOLUTION 28A
(i) Current Yield : = = = = 15.55%
Yield to Maturity
–
Alt 1: By Approximation Formula YTM = = 16.84%
Alt 2: By IRR Formula
90 = + +…. +
( ) ( ) ( ) ( )
90 = 14 × PVAF (YTM, 5 years) + 100 × PVF (YTM, 5 years)
Let YTM = 15%: NPV = (14 × 3.352 + 100 × .497) -90 = (46.928 + 49.7) - 90 = + 6.628
Let YTM = 20%: NPV = (14 × 2.991 +100 × .402) -90 = (41.874 + 40.2) - 90 = ˗ 7.926
. .
YTM = 15 + ( )
× (20 - 15) = 15 + × 5 = 17.27%
. . .
(ii) Duration of the bond
= 1 × + 2 × + 3× + 4 × +5 × + 5 × =
( . ) ( . ) ( . ) ( . ) ( . ) ( . )
3.8524 years (approx)
Realized Yield
( )
90 = => 90 (1 + YTM)5 = 170 => (1+YTM) = √1.89 = 1.11357
( )
YTM =13.57%
SOLUTION 28B
(i) Current yield = × =0.1555 or 15.55%
YTM can be determined from the following equation
7 × PVIFA (YTM, 10) + 100 × PVIF (YTM, 10) = 90
Let us discount the cash flows using two discount rates 7.50% and 9% as follows:
Year Cash Flows PVF@7.50% PV@7.50% PVF@9% PV@9%
0 -90 1 -90 1 -90
1 7 0.930 6.51 0.917 6.419
2 7 0.865 6.055 0.842 5.894
3 7 0.805 5.635 0.772 5.404
4 7 0.749 5.243 0.708 4.956
5 7 0.697 4.879 0.650 4.550
6 7 0.648 4.536 0.596 4.172
 10.12 FIXED INCOME SECURITIES

7 7 0.603 4.221 0.547 3.829

8 7 0.561 3.927 0.502 3.514
9 7 0.522 3.654 0.460 3.220
10 107 0.485 51.90 0.422 45.154
6.560 -2.888
Now we use interpolation formula
.
= 7.50% + × 1.50%
. ( . )

.
7.50% + ×1.50% =7.50% + 1.041%
.
YTM = 8.541% say 8.54%
Note: Students can also compute the YTM using rates other than 15% and 18%.
(ii) The duration can be calculated as follows:
Year Cash Flow PVF@ PV @ 8.54% Proportion of NCD Proportion of NCD
8.54% value value × time
1 7 0.921 6.447 0.0717 0.0717
2 7 0.849 5.943 0.0661 0.1322
3 7 0.782 5.474 0.0608 0.1824
4 7 0.721 5.047 0.0561 0.2244
5 7 0.664 4.648 0.0517 0.2585
6 7 0.612 4.284 0.0476 0.2856
7 7 0.563 3.941 0.0438 0.3066
8 7 0.519 3.633 0.0404 0.3232
9 7 0.478 3.346 0.0372 0.3348
10 107 0.441 47.187 0.5246 5.2460
89.95 7.3654
Duration = 7.3654 half years i.e. 3.683 years.
(iii) Realized Yield can be calculated as follows:
( × )
=90
( )

(1 + 𝑅) =
/
R= -1= 0.06380 or 6.380% for half yearly and 12.76% annually.

SOLUTION 29A
1. Calculation of Current Market Price :
160 × PVAF (17%, 6 years) + 1,000 × PVF (17% 6 years) = 160 × 3.589 + 1000 × .390
= 574.24 + 390 = 964.24
2. Duration of Bond :
× × × × × ×
= + + + + + +
. ( . ) ( . ) ( . ) ( . ) ( . ) ( . ) ( . )

= × 4091.2 = 4.243 Years

.
.
3. Volatility of Bond : = = 3.626
.
Change In Market Price IF Yield increases to .75
Revised Yield or new Yield = 17 + .75 = 17.75
4. Expected Market Price:
= 160 × PVAF (17.75%, 6 years) + 1000 × PVF (17.75%, 6 years)
= 160 × 3.52 + 1000 × .375 = 563.2 + 375 = 938
 10.13

SOLUTION 29B
(i) Calculation of Market price:

YTM =

Discount or premium – YTM is more than coupon rate, market price is less than Face Value i.e. at discount.
Let x be the market price

0.15 =
x = ₹ 834.48
(ii) Duration
Year Cash flow P.V. @ 15% Proportion of bond Proportion of bond value
value x time
(years)
1 110 .870 95.70 0.113 0.113
2 110 .756 83.16 0.098 0.196
3 110 .658 72.38 0.085 0.255
4 110 .572 62.92 0.074 0.296
5 110 .497 54.67 0.064 0.320
6 1110 .432 479.52 0.565 3.39
848.35 1.000 4.570
Duration of the Bond is 4.570 years
(iii) Volatility
.
Volatility of the bond = = = 3.974
( ) .
(iv) The expected market price if increase in required yield is by 100 basis points.
= ₹ 834.48 × 1.00 (3.974/100) = ₹ 33.162
Hence expected market price is ₹ 834.48 – ₹ 33.162 = ₹ 801.318 Hence, the market price will decrease
(v) The expected market price if decrease in required yield is by 75 basis points.
= ₹ 834.48 × 0.75 (3.974/100) = ₹ 24.87
Hence expected market price is ₹ 834.48 + ₹ 24.87 = ₹ 859.35 Hence, the market price will increase
SOLUTION 30A
(i) Stock Value or Conversion Value of Bond : Conversion Value = 12x20 = ₹ 240
(ii) The difference between Market value of convertible Bond & Market value of Straight Coupon Bond represents
downside risk. This reflects the extent of decline in market value of convertible Bond at which conversion
option becomes worthless.
The Percentage of Downside Risk : = =12.77%
This ratio gives the percentage price decline experienced by the bond if the conversion option becomes
worthless.
( )
(iii) Conversion Premium = x 100
( )
= x 100 = 10.42%
(iv) Conversion Party Price :
= = = ₹ 13.25
.
This indicate that if the price of share rises to ₹ 13.25 from ₹ 12, the investor will neither gain nor loss on
buying the bond and exercising the conversion option.
SOLUTION 30B
Conversion rate is 14 shares per bond. Market price of share ₹ 80
Conversion Value 14 x ₹ 80 = ₹ 1120
Market price of bond = ₹ 1475
Premium over Conversion Value (₹ 1475- ₹ 1120) = x 100 = 31.7%
 10.14 FIXED INCOME SECURITIES

SOLUTION 30C
(i) As per the conversion terms 1 Debenture = 10 equity share and since face value of one debenture is ₹ 5000
the value of equity share becomes ₹ 500 (5000/10).
The conversion terms can also be expressed as: 1 Debenture of ₹ 500 = 1 equity share.
The cost of buying ₹ 500 debenture (one equity share) is:
₹500× =₹540
Market Price of share is ₹ 430. Hence conversion premium in percentage is:
×100 = 25.58%

(ii) The conversion value can be calculated as follows:

Conversion value = Conversion ratio X Market Price of Equity Shares
= 10 × ₹ 430 = ₹ 4300
SOLUTION 30D
(a) Calculation of market value of each convertible bond
Expected share price in five years’ time = £ 4.45 x ( 1+.065)5 = £ 6.10
Conversion value at the end of years 5 = £ 6.10 x 20 = £ 122
Compared with redemption at par value of £ 100, conversion will be preferred
The current market value will be the present value of future interest payments, plus the present value of the
conversion value, discounted at the cost of debt of 7% per year.
Market value of each convertible bond = ( £ 9 x4.1) + (£ 122x 0.713) = £ 123.89
(c) Calculation of conversion premium of each convertible bond
Current conversion value = £ 4.45 x 20 = £ 89.00
Conversion premium = £123.89 - £ 89.00 = £34.89
This is often expressed on a per share basis, i.e. £ 34.89/20 = £ 1.75 per share
SOLUTION 30E
(i) Conversion value of preference share
2 × ₹ 21 = ₹ 42
Conversion Ratio × Market Price
(ii) Conversion Premium
(₹ 50/ ₹ 42) - 1 = 19.05%
(iii) Effect of the issue on basic EPS
BEFORE CONVERSION ₹
Total (after tax) earnings 3 × ₹ 5,00,000 15,00,000
Dividend or Preference shares 1,40,000
Earnings available to equity holders 13,60,000
No. of shares 5,00,000
EPS 2.72
ON DILUTED BASIS
Earnings 15,00,000
No of shares (5,00,000 + 80,000) 5,80,000
EPS 2.59
(iv) EPS with increase in Profit
₹
Earnings 25,00,000
Dividend on Pref. shares 1,40,000
Earning for equity shareholders 23,60,000
No. of equity shares 5,00,000
EPS 4.72
On DILUTED BASIS
Earnings 25,00,000
No. of shows 5,80,000
EPS 4.31
 10.15

SOLUTION 30F
Premium over Conversion Value or Conversion Premium
(
= × 100
( )
= × 100 = 4.865%
Premium over Investment Value
(
× 100
( )
= × 100 = 11.494%
Conversion Parity Price =
= = ₹ 19.40
.
Breakeven Period :
Breakeven Period = = = 5 years
The period of 5 years indicates that with the present projections the bonds holders should plan for a holding horizon
of 5 year before converting into stock.
Note : Excess value on Conversion of Debt into Equity = Value of Debt – Value of Equity
= 970 - 18.50 × 50= 45
Annual Excess Receipt of Debt over Equity = Annual interest – Annual Dividend
= 1000 × 11.5% - 50 × 2.12 = 9
SOLUTION 30G
1. Conversion Value of Debenture
= Market Price of one Equity Share × Conversion Ratio = ₹ 25 × 30 = ₹ 750
2. Market Conversion Price
= = = ₹ 30
3. Conversion Premium per share
= Market Conversion Price - Market Price of Equity Share
= ₹ 30 - ₹ 25 = ₹ 5
4. Ratio of Conversion Premium
= = = 20%
5. Premium over Straight Value of Debenture

= –1= – 1 = 28.6%
6. Favourable income differential per share

×
=
×
= = ₹ 1.833
7. Premium pay back period

= = 5 1.833 = 2.73 Years

SOLUTION 30H
(a) Straight Value of Bond
₹ 85 x 0.9132 + ₹ 85 x 0.8340 + ₹ 1085 x 0.7617 = ₹ 974.96
(b) Conversion Value
Conversion Ration x Market Price of Equity Share
= ₹ 45 x 25 = ₹ 1,125
(c) Conversion Premium
Conversion Premium = Market Conversion Price - Market Price of Equity Share
,
= - ₹ 45 = ₹ 2
or = ₹ 1,175 - ₹ 45 x 25 = ₹ 50
 10.16 FIXED INCOME SECURITIES

, ,
or = 4.47%
,
(d) Percentage of Downside Risk
, .
= ×100 = 20.52%
.
(e) Conversion Parity Price

.
,
= = ₹ 47

SOLUTION 30I
(i) Current Market Price of Bond
Time CF PVIF 8% PV (CF) PV (CF)
1 14 0.926 12.964
2 14 0.857 11.998
3 14 0.794 11.116
4 14 0.735 10.290
5 114 0.681 77.634
× PV (CF) i.e. P0 = 124.002

Time CF PVIF 8% PV (CF) PV (CF)

1 14 0.926 12.964
2 14 0.857 11.998
3 14 0.794 11.116
4 14 0.735 10.290
5 114 0.681 77.634
× PV (CF) i.e. P0 = 124.002
Say ₹ 124.00
(ii) Minimum Market Price of Equity Shares at which Bondholder should exercise conversion option:
𝟏𝟐𝟒
=₹ 6.20
𝟐𝟎
(iii) Duration of the Bond
Year Cash flow P.V. @ 8% Proportion of Proportion of
bond value bond value x
time (years)
1 14 0.926 12.964 0.105 0.105
2 14 0.857 11.998 0.097 0.194
3 14 0.794 11.116 0.089 0.267
4 14 0.735 10.290 0.083 0.332
5 114 0.681 77.634 0.626 3.130
124.002 1.000 4.028
SOLUTION 31A
The bond refunding decision can be analyzed as a capital budgeting decision. The present value of the stream of
net cash savings exceeds the initial cash outflows the debt should be refunded.
Calculation of Net Initial outflow:
, , ,
Initial outflow for replacement of bonds: × 1050 = ₹ 315,00,000
Initial Inflow on issue of New Bonds: Issued Value Less Issued Cost
i.e. 3,00,00,000 - 9,00,000 = ₹ 2,91,00,000
Net Initial Outflow = ₹ [315 lakh - 291 ] = 24 lakh.
Note: Face value of bond has been assumed to be ₹ 1000
Tax Saving on Call Premium and Unamortised Issued Cost:
The call premium and unamortized issue cost on old bonds can be written off as an expense in the year in which
the call is made. It is assumed morally that there will be tax benefit available immediately on these two expenses.
 10.17

Call Premium [ 315-300 ] lakh = 15 lakh

Unamortized issue cost 30,000x12 = 3.60 lakh
Total amount to be written off = 18.60 lakh
Tax saving on the above : 50% of 18.60 lakh 9.30
Annual cash Outflow :
Existing :
Annual interest : 12.5% x 300 lacs = 37.5 lakh
Amortization of issue costs p.a. = .30 lakh
Tax saving on above = 50% ( 37.5 lakh +.3 lakh ) = 18.90 lakh
Net annual cash Outflow = ( 37.5-18.90) lakh = ₹ 18.60 lakh
New Issue
Annual Interest : 10% of 300 lacs = 30 lacs
, ,
Amortization of issued cost p.a = = .75 lac
Tax saving on above : 50% ( 30 +.75 ) lakh = 15.375 lakh
Net annual cash outflow = ( 30-15.375) lakh = 14.625 lakh
Annual saving on cash outflow = ( 18.6 – 14.625) lakh = 3.975 lakh per annum
Calculation of total net savings by replacing outstanding bonds with new issued of bonds :
Particulars Time PVF @ 6% Amt. ( in lacs) PV ( in lacs)
Initial cash outflows 0 1 -24 -24
Tax saving on call premium & 0 1 9.30 +9.30
unamortized issue cost
Annual savings 1-12 8.38 3.975 +33.3105
Net present value 18.6105
Recommendation: Refunding of bonds is recommended as NPV is positive.
Note: Since bond face value is silent, it is assumed to be ₹1000.
SOLUTION 31B
Net Initial Outflow
, , ,
Initial outflow for replacement of old bond : × 1140 = ₹ 342, 00,000
Initial Inflow on issue of New bonds: Issue value Less Issue Cost
i.e. 30,000,000 - 4,00,000 = 296,00,000
Net Initial Outflow = [ 342 lakh - 296 lakh ] = 46 lakh
Call Premium, Unamortised issue cost and Unamortised Discount.
The call premium, unamortised issue cost and unamortised amount of discount on old bonds can be written off as
an expense in the year in which the call is made. It is assumed normally that there will be tax benefit available
immediately on these three expenses.
Call premium [ 1140-1000] x 30,000 42 lakh.
, ,
Unamortised Issue cost: x 25 3 lakh
, ,
Unamortised Discount on Old Bonds: x 25 7.5 lakh
Total amount to be written offf 52.5 lakh
Tax saving due to above claim : 40% of 52.5 21 lakh
Annual Cash Outflow :
Existing :
Annual Interest : 14% 300 lacs = 42 lacs
Amortisation of issue cost p.a. .
= .12 lacs
Amortisaiton of discount = .30 lacs

Tax saving on above = 40% ( 42 lakh + . 12 lakh + .30 lakh ) = 16.968 lacs
Net Annul cash Outflow = 42-16.968 = ₹ 25.032 lacs
 10.18 FIXED INCOME SECURITIES

New Issue
Annual Interest : = 12% of 300 lacs = 36 lacs
, ,
Amortisation of issue cost p.a. = = .16 lacs
Tax saving on above : = 40% ( 36+ .16 ) lacs = 14.469.
Net annual cash outflow = ( 36-14.469) = 21.536 lacs.
Annual saving on cash outflow Due to New Issue = ( 25.032-21.536) lacs = 3.496 lacs .
Overlapping Interest
300 lacs x 14% x = 7,00,000
(-) tax saving @ 40% = 2,80,000
Net cost = 4,20,000
Calculation of Total Net Saving by Replacing outstanding Bods with New Issue of Bonds :
Particulars Time PVF @ 8% Amt. ( in lakh) PV ( in lakh)
Initial cash outflow taxa 0 1 46 -46
saving on call premium
Unamortised issue cost and 0 1 21 +21
discount amount
Overlapping Interest net of 0 1 4.2 -4.20
tax
Annul Saving 1-25 10.675 3.496 37.31980
Net Present Value 8.1198
Recommendation : Refunding of bonds is recommended as NPV is positive.
SOLUTION 31C
1. Calculation of initial outlay:- ₹ (lakhs)
a. Face Value 200.00
Add : Call premium 10.00
Cost of calling old bonds 210.00
b. Gross proceed of new issue 200.00
Less : Issue costs 2.50
Net proceeds of new issue 197.50
c. Tax savings on call premium and unamortized cost 0.30 (10+3) ₹ 3.90 lakhs
∴ Initial outlay = ₹ 210 lakhs - ₹ 197.50 lakhs - ₹ 3.90 lakhs 8.60 lakhs
2. Calculation of net present value of refunding the bond:- ₹ (lakhs)
Saving in annual interest expenses
[₹ 200 x (0.11 - 0.09)] 4.000
Less:-Tax saving on interest and amortization 0.30 x [4+(3-2.5)/10] 1.215
Annual net cash saving 2.785
PVIFA (7%, 10 years) 7.024
∴ Present value of net annual cash saving ₹ 19.56 lakhs
Less : Initial outlay ₹ 8.61 lakhs
Net present value of refunding the bond ₹ 10.96 lakhs
Decision : The bonds should be refunded
SOLUTION 32A
(i) Intrinsic value of Bond
PV of Interest + PV of Maturity Value of Bond Forward rate of interests
1st Year 12%
2nd Year 11.25%
3rd Year 10.75%
PV of interest = + + = ₹ 217.81
( . ) ( . )( . ) ( . )( . )( . )

PV of Maturity Value of Bond = = ₹ 724.67

( . )( . )( . )
 10.19

Intrinsic value of Bond = ₹ 217.81 + ₹ 724.67 = ₹ 942.48

(ii) Expected Price = Intrinsic Value x Beta Value
= ₹ 948.48 x 1.02 = ₹ 961.33
SOLUTION 32B
1. Consider one year Government Security:
, , , ,
91,500 =  1+r =
( ,
 r = 0.0929 or 0.093 or 9.3%
2. Consider two year Government Security:
, , , , ,
98,500= ( )
+( )×(
 98,500 = 9149.131+ ( )×(
. . ) . )
.
 9350.87 =  r = 0.12635 or 12.635%
3. Consider three year Government Securities:
, , , ,
99,000 = + + ( ) ( )
( . ) ( . ( . ) ( .
.
 9000 = 9606.587+8529.65+
.
 0863.763 =  1+r = 1.1100697
 r = 1100697 or 11.00697%
SOLUTION 32C
i) Forward Rates for year 2 & years 3:
For year 2: ( )(
=( )
 (1+0.1050) ( 1+ X) = ( 1+ 0.1125)2 = 12%
. ) .

For year 3: ( )( )( )
=( )
 (1 +.1050 )(1+.12) (1+X) = ( 1+1.12)3
. . .
 X = 13.52%
×( . )
ii) Percentage Change in the Price of the Bond: B0 = ( )
= 978
.
Therefore, % change in the price of the bond = × 100 = - 2.2%

SOLUTION 32D
To get forward Interest rates, begin with the one year Government Security
₹ 91,000 = Rs 1,00,000 / (1+ r)
r = 9.9%
Then consider the two year Government Security
₹ 99,000 = (₹ 10,500/1.099) + {₹ 1,10,500 / (1.099)(1+r)}
r = 0.124
Then consider the three year Government Security
₹ 99,500= (₹ 11,000/1.099) + {₹ 11,000/ (1.099(1.124)} + {1,11,000 / (1.099) ( 1.124) ( 1+r)}
r = 0.115
Finally consider the four year Government Security
₹ 99,900= (₹ 11500/1.099) + {₹ 11,500/(1.099)(1.124)} + { ₹ 11,500/(1.099)(1.124)(1.115)} + { ₹ 11,500 /
(1.099) (1.124) (1.115) (1+r)}
r = 0.128
SOLUTION 34A
Duration of Bond X
Year Cash flow P.V. @ Proportion of Proportion of bond value
10% bond value x time (years)
1 1070 .909 972.63 1.000 1.000
Duration of the Bond is 1 year
Duration of Bond Y
Year Cash P.V. @ 10% Proportion of bond Proportion of bond value
flow value x time (years)
1 80 0.909 72.72 0.077 0.077
2 80 0.826 66.08 0.071 0.142
 10.20 FIXED INCOME SECURITIES

3 80 0.751 60.08 0.064 0.192

4 1080 0.683 737.64 0.788 3.152
936.52 1 3.563
Duration of the Bond is 3.563 years
Let x1 be the investment in Bond X and therefore investment in Bond Y shall be (1 - x1). Since the required duration
is 2 year the proportion of investment in each of these two securities shall be computed as follows:
2 = x1 + (1 - x1) 3.563
x1 = 0.61
Accordingly, the proportion of investment shall be 61% in Bond X and 39% in Bond Y respectively.
Amount of investment
Bond X Bond Y
PV of ₹ 1,00,000 for 2 years @ 10% x 61% PV of ₹ 1,00,000 for 2 years @ 10% x 39%
= ₹ 1,00,000 (0.826) x 61% = ₹ 1,00,000 (0.826) x 39%
= ₹ 50,386 = ₹ 32,214
No. of Bonds to be purchased No. of Bonds to be purchased
= ₹ 50,386/₹ 972.73 = 51.79 i.e. approx. = ₹ 32,214/₹ 936.52 = 34.40 i.e.
52 bonds approx. 34 bonds
Note: The investor has to keep the money invested for two yea₹ Therefore, the investor can invest in both the bonds
with the assumption that Bond X will be reinvested for another one year on same returns
SOLUTION 34B
(a) Calculation of Bond Duration
Bond A
Year Cash flow P.V. @ 9% Proportion of Proportion of
bond value bond value x time (years)
1 10 0.917 9.17 0.086 0.086
2 10 0.842 8.42 0.079 0.158
3 10 0.772 7.72 0.073 0.219
4 10 0.708 7.08 0.067 0.268
5 10 0.650 6.50 0.061 0.305
6 10 0.596 5.96 0.056 0.336
7 10 0.547 5.47 0.051 0.357
8 10 0.502 5.02 0.047 0.376
9 10 0.460 4.60 0.043 0.387
10 110 0.4224 46.46 0.437 4.370
106.40 1.000 6.862
Duration of the bond is 6.862 years or 6.86 year
Bond B
Year Cash flow P.V. @ 9% Proportion of bond Proportion of bond value x
value time (years)
1 11 0.917 10.087 0.091 0.091
2 11 0.842 9.262 0.083 0.166
3 11 0.772 8.492 0.076 0.228
4 11 0.708 7.788 0.070 0.280
5 11 0.650 7.150 0.064 0.320
6 11 0.596 6.556 0.059 0.354
7 11 0.547 6.017 0.054 0.378
8 111 0.502 55.772 0.502 4.016
111.224 1.000 5.833
 10.21

Duration of the bond B is 5.833 years or 5.84 years

Bond C
Year Cash flow P.V. @ 9% Proportion of bond Proportion of bond value x
value time (years)
1 9 0.917 8.253 0.082 0.082
2 9 0.842 7.578 0.076 0.152
3 9 0.772 6.948 0.069 0.207
4 9 0.708 6.372 0.064 0.256
5 109 0.650 70.850 0.709 3.545
100.00 1.000 4.242
Duration of the bond C is 4.242 years or 4.24 years
(ii) Amount of Investment required in Bond B and C
Period required to be immunized 6.000 Year
Less: Period covered from Bond A 3.087 Year
To be immunized from B and C 2.913 Year
Let proportion of investment in Bond B and C is b and c respectively then
b + c = 0.55 (1)
5.883b + 4.242c = 2.913 (2)
On solving these equations, the value of b and c comes 0.3534 or 0.3621 and 0.1966 or 0.1879 respectively
and accordingly, the % of investment of B and C is 35.34% or 36.21% and 19.66 % or 18.79% respectively.
(iii) With revised yield the Revised Duration of Bond stands
0.45 x 7.15 + 0.36 x 6.03 + 0.19 x 4.27 = 6.20 year
No portfolio is not immunized as the duration of the portfolio has been increased from 6 years to 6.20 years.
(iv) New percentage of B and C bonds that are needed to immunize the portfolio.
Period required to be immunized 6.0000 Year
Less: Period covered from Bond A 3.2175 Year
To be immunized from B and C 2.7825 Year
Let proportion of investment in Bond B and C is b and c respectively, then
b + c = 0.55
6.03b + 4.27c = 2.7825
b = 0.2466
On solving these equations, the value of b and c comes 0.2466 and 0.3034
respectively and accordingly, the % of investment of B and C is 24.66% or 25% and
30.34 % or 30.00% respectively.