Assignment 3 (replaces previous assignment 3)

More practice problems on bond prices and bond yields

1. A $1000 20 year corporate bond in the US was issued in May of 2014. It paid a 6% coupon, but
coupons are paid semi-annually. The bond was issued with a call provision that it could be called
back in 6 years (in May of 2020), but the company would have to pay a 4% call premium to
investors. (This premium is 4% of face value regardless of the trading price of the bond in 2020).
a. Determine the yield to call for investors if this bond was called away in May of 2020.
b. The company issued 5000 of these $1000 bonds back in 2014 to raise $5 million. Should the
company call them back, pay the call premium, and issue new bonds that it could sell at
1000 face value with a 4.6% annual coupon for a period of 14 years (28 semi-annual
periods)? It would also have to pay $60,000 in fees, commissions, and reissuance costs.
(let’s postpone this until the end of class or even after class. It requires an NPV analysis)

2. Consider a 20 year $1000 bond with a put provision that can be exercised after 4 years. The
puttable price is $980. The bond pays an 8% coupon, but payments are semi-annually. After 4
year, or 8 periods, let’s assume that interest rates have risen to 10% annually.
a. Determine the market price of the bond four years after its issuance.
b. Determine the investor’s yield to put.
c. Should the investor exercise the put option?

3. A 30-year $100,000 US Treasury bond has a quoted price of 108-30+ on September 4, 2023 at
the end of the day. So . It pays semi-annual coupons on March 31 and September 30. The
coupon rate is 5.4% annually. Assume that 157 days have passed since the last coupon was paid
a. Determine its clean price (round to the nearest cent or $0.01 because that is likely what you
pay)
b. Determine the amount of interest that would be due to the seller at the end of the day on
September 5 (round to nearest $0.01)
c. Determine the full price or the dirty price of the bond (round to nearest $0.01)

4. The US Treasury issued a 30-year TIPS paying a 2% annual real coupon today. Let’s assume you
buy a $100,000 TIPS and that payments are made semi-annually. Assume that the inflation rate
annualized will be 8% for the first 6 months and 10% annualized for the second 6 months
(Hopefully, these are not realistic numbers). Let’s just look at one year. For these numbers
determine:
a. The inflation-adjusted principal after 6 months
b. The first coupon payment
c. The inflation-adjusted principal after 12 months (6 months after first coupon)
d. The second coupon payment
N=30

r.pmt=2%

TIPS = 100000

1st 8%/2=4%

2: 10%/2=5%

The inflation adjustment after six months: 100000*0.04 = 4000 ==>100000+4000=104000

First coupon payment: 104000*(0.02/2) = 1040

After 6 more months: 104000*0.05= 5200

104000+5200=109200 the new inflation-adjusted principal

Second coupon pmt: 109200*(0.02/2)=1092