CORPORATE FINANCE
SEMINAR WORK: BOND VALUATION
QUESTION ONE
The yield curve of 8% bond, redeemable in 5 years’ time at its face value
of £100, has the following term structure of interest rates (as depicted
by the yield curve):
Year
1
2
3
4
5
Spot Rate (%)
4.00
4.50
5.00
5.50
6.00
REQUIRED
a.
Explain how the amount of coupon payable and the time to
maturity affect the sensitivity of a bond.
b.
Estimate the value of the bond and its yield to maturity.
c.
Estimate the bond’s Macaulay duration and its modified duration.
d.
Estimate, in percentage terms, how much the bond’s new value
would fall by, if interest rates rise by 0.5% for all years based on
the modified duration figure.
e.
Explain why this value is only approximately correct.
QUESTION TWO
Estimated spot interest rates (term structure of interest rates or yield
curve) are as follows:
Year
1
2
3
4
5
Spot Rate (%)
5.00
5.40
5.70
5.90
6.00
REQUIRED:
a.
Calculate the value of a 5% £100 bond, redeemable in 5 years at
par based on the above yield curve.
b.
Calculate the yield to maturity of the bond. Explain intuitively why
the yield to maturity on a 10% coupon bond is less than the yield
to maturity on a 5% coupon bond.
c.
On a 5-year zero bond, what would you expect the yield to
maturity to be?
d.
Given the spot rate in four years what can you deduce if:
The Expectations theory is correct?
The Liquidity Preference theory is correct?
QUESTION THREE
Duration measures or assesses the sensitivity of bonds to interest rate
changes, but how is riskiness of corporate bonds assessed and
managed, especially with respect to default risk?