February 5, 2013
Week 2 Text Problem Set
4. Define the following terms: bond indenture, par value, principal, maturity, call provision, and sinking fund.
• Bond indenture: A contract for a bond defining specified terms for interest and borrowed capital to be repaid to the lender. • Par value: “Specifies the amount of money that must be repaid at the end of the bond’s life, which is also called face value or maturity value” (Emery, Finnerty, & Stowe, 2007, p. 112). • Principal: The original amount of debt or balance borrowed, which does not include interest. • Maturity: The life end of a contractual obligation.
• Call provision: The right for the issuer to payoff bonds prior to the maturity date (Emery, Finnerty, & Stowe, 2007). • Sinking funds: Bon repayment in multiple installments (Emery, Finnerty, & Stowe, 2007).
11. What is interest-rate risk? How is interest-rate risk related to the maturity of a bond and to the coupon rate for a bond?
“Interest-rate risk is the sensitivity of a bond’s value to interest-rate change as it depends primarily on the bond’s remaining maturity” (Emery, Finnerty, & Stowe, 2007, p. 132). An issued bond pays a fixed rate of interest called a coupon rate until it matures. The current prevailing interest rates and the perceived risk of the issuer are related to the rate. Upon a bond sale on the secondary market prior to the maturity date will affect the value of the bond and not the coupon as the rates are based on the market interest rates as the time of sale.
A6. (Yield to maturity) Marstel Industries has a 9.2% bond maturing in 15 years. What is the yield to maturity if the current market price of the bond is: a. $1,120? b. $1,000? c. $785? a. Current Price $1,120
• n = 15x2 = 30r = ? PV = -$1,120
• PMT = 9.2%x1,000/2 = $46.00 FV = $1,000
• r = 3.9133%
• YTM = 3.9133%x2...