Present Value, Yield to Maturity, and Bond Prices



Present Value, Yield to Maturity, Bond Prices and Total Returns

Class Exercise

PRESENT VALUES

1. BRING DAMON BACK

The Red Sox are trying to bring Johnny Damon back. At the next negotiations, the Sox offer him a signing bonus of $3,000,000 (received immediately), an initial salary at the end of the first year of $6,000,000 with an increase of $1,000,000 each year for two years after that. The Yankees meanwhile offer him a signing bonus of $6,000,000, a salary in the first year of $5,500,000, and a second and third year’s salary of $6,000,000. If the interest rate is 10%, which offer will Johnny prefer? If the interest rate were 5%, which offer should he accept?

2. BOND CHOICES

You are offered a coupon bond for x dollars that pays a coupon payment of $500 a year from now, and pays $5500 two years from now. The interest rate is 10%. What is the maximum you should be willing to pay for the bond (that is—what is the maximum value of x you should accept)?

3. MAGAZINE CHOICES

The Economist costs $50 for a one year subscription and $96 for a two year subscription (4$ off!- the ads say). You would like to get the magazine for two years. If the interest rate were 10%, what is the better choice? What information is lacking that might make you choose the other option anyway?

4. FORMULA FOR YTM

Write down the formulae to get the yield to maturity of the following assets:

i) A corporate bond with a face value of $10,000 with a coupon payment of $800 with three years to maturity

ii) A student loan for $5000 for which $350 must be paid for 20 years, starting two years after graduation this year.

5. DISNEY BONDS

You have bought a four-year $1,000 Disney bond with a coupon payment of 60 dollars every year. The market rate is 6%. What is the bond worth today and what is its current yield? If the market rate drops to 5% immediately after you buy it, what is the value of the bond and what is its current yield? What does this tell you about the relationship between the value of a bond and its yield?

6. TOTAL RETURNS

You bought 100 shares of ABC Stock for $55 per share. ABC paid dividends of $2 per share in the first year and at the end of the year its price was $60. What total return did you receive?

1) 7. Explain the following report. In particular, explain carefully the relationship alluded to in the headline. Explain also what is meant by the yield in the first and second paragraphs.

Bonds fall on Fed rate hike speculation

Treasury prices ease after economic group suggests central bank may keep raising rates; dollar gains.

September 5 2006: 6:25 PM EDT

NEW YORK () -- Treasury prices slipped Tuesday after a group issued a report that suggested that the Federal Reserve may need to resume raising interest rates

The 10-year Treasury note closed down 13/32, or $4.06, on a $1,000 note to yield 4.78 percent, up from 4.73 late Friday.

The 30-year bond slipped 22/32, or $6.87 on a $1,000 bond, to yield 4.93 percent, up from 4.87 percent in the previous session

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