6.3.3
What care, if any, should be taken regarding the sign of the cash flows while drawing the timeline and associated cash flows of a coupon bond?
Answer: A typical coupon bond will have the first cash flow in the opposite direction as compared to all the rest of the cash flows over its life. The first cash corresponds to the issuer borrowing the money, while all the rest of the cash flows are payments by the issuer to the bondholder either in the form of interest or principal.
The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semiannually. How much are each of the semiannual coupon payments? Assuming the appropriate YTM on the Sisyphean bond is 8.8%, then at what price should this bond trade for?
Answer: Coupon payments = (coupon rate × face value) / number of coupons per year = (.08 × $1,000) / 2 = $40 FV = 1,000I = 4.4% (8.8/2)PMT = $40 ($80/2)N = 30 (15 × 2) Compute PV = $934.07
Assuming that this bond trades for $1,035.44, then the YTM for this bond is equal to ________.
Answer: FV = $1,000 PMT = 40 (80 / 2) N = 30 (15 × 2)PV = -$1,035.44Compute I = 3.8 × 2 = 7.6 or 7.6%
How can the financial calculator be used to calculate the price of a coupon bond from its yield to maturity?
Answer: Most popular financial calculators can help compute the price of a coupon bond in several ways. Two such ways may be using ʹtime value of money (TVM) keys and cash flow (CF) keys.
21) The following table summarizes prices of various default-free zero-coupon bonds (expressed as a percentage of face value): Based upon the information provided in the table above, you can conclude ________. A) that the yield curve is flat B) nothing about the shape of the yield curve C) that the yield curve is downward sloping D) that the yield curve is upward sloping
C
What issues should one be careful of when calculating the bond price from its yield to maturity using the time value of money (TVM) keys of a financial calculator?
It is quite simple to transfer the bond cash flow timeline to a financial calculator. Care has to be taken when using the TVM keys in understanding that the last cash flow, i.e., the return of principal by the issuer, is automatically augmented by the last coupon payment and no special steps are needed for that.
What issues should one be careful of when calculating the bond price from its yield to maturity using the cash flow (CF) keys of a financial calculator?
There are two issues that one has to be careful about when using the CF keys in computing the price of coupon bonds from its yield to maturity. Since the coupon payments are generally identical over the life of the bond, it might be prudent to use the frequency key while entering this cash flow. That is the first pitfall to be aware of as the frequency to be entered into the calculator has to be reduced by one to account for the last coupon payment that gets added to the return of principal. Similarly, the last cash flow has to be the sum of principal and the last coupon payment.
What care, if any, should be taken regarding the timing of the cash flows while drawing the timeline and associated cash flows of a coupon bond?
There are two issues that one has to be careful of in marking the timing of cash flows associated with a coupon bond. The first is to be cognizant of the periodicity of the coupon payment, as most coupons are not paid annually. The second is to make sure that the return of principal at the end of the life also has a last coupon payment associated with it.
