Chapter 06 BUA321
Chapter 6 Interest Rates and Bond Valuation
1) What is the real rate of interest? Can this rate be controlled?
2) What is the risk free rate? Can we find this interest rate?
3) The government offers I-Bonds. These bonds are identical to the usual government bonds, except that they are inflation adjusted. a) What does inflation adjusted mean? b) What is the relation between the returns of the US Treasury Bond and the I-Bond? c) What is the relationship between the prices?
4) What is the Term Structure of Interest Rates?
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
5) What is the relationship between the stock market and the bond market? http://stockcharts.com/charts/yieldcurve.html
6) How can you explain the two theories of how the yield curve is created? a) Expectations Theory b) Liquidity Preference Theory
7) The real rate of interest is 2.45%. The inflation premium is 3.13%. What is the approximate nominal rate? a) What is the Fisher Effect nominal rate? b) Are these equal? Why or why not?
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
8) Can you describe a corporate bond? What are its characteristics?
9) How do the following factors impact interest rates? Prices of Bonds? a) Length to maturity b) the size of the offering c) the default risk of the issuing firm d) the cost of money in the capital market
10) How does this table reflect risk? What is true in general about the prices of differently rated bonds?
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
11) Basic Valuation Model
12) Let’s review the basic investment rules a) If Value >= Price, buy the asset i) Price is known, so we must solve for value b) If Expected return >= required return, buy the asset i) Expected return = return if we buy at the current price and the cash flows actually occur ii) Required return reflects risk, inflation, and real rates of return
13) You can buy a 30 year zero coupon bond with a required return of 8%. What is the value of this bond?
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
14) A bond is selling for $900. It has a coupon of 3.5% and a maturity of 20 years. This bond has a S&P rating of AA. What is the value of the bond? If you purchased this bond, what would the YTM be?
15) What causes bond prices to change over time?
16) What is a Bond? This might clear up some questions!! http://www.youtube.com/watch?feature=player_detailpage&v=eE-vj43wHOQ
17) Final analysis let’s discuss the following questions: a) If you buy a bond today for $900 that matures in 20 years, what will its value be in 10 years? b) When it matures in 20 years, what is its value?
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
18) When you by a bond, how do you make money?
19) Bond Examples a) What is the value of a 15 year, 5% coupon bond with a required return of 8%? b) What is the value of a 15 year, 10% coupon bond with a required return of 8%? c) If you bought the bond in (a) for its value, what is your YTM? Would you buy this bond? d) If you bought the bond in (b) for its value, what is your YTM? Would you buy it? e) Describe the return earned on bond (a)? bond (b)? f) How can you reconcile this?
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
Homework (39 points) ______ Research (22 points) ________
Chapter 6 Homework assignment (Problems are from the textbook.)
1) The current interest rate for a 5 year Treasury note is .75%. IF the current inflation rate is
.1% what is the real rate.
2) The current rate on a 30 year Treasury bond is 3.2%. If the real rate is approximately
2%, what is the inflation rate.
3) If a corporate AAA rated bond yields 5.6%, what is the risk premium given the 30 year treasury rate in question 2?
4) Valuation (time value worksheets) (6)
Discount rate Value
10%
Cash flow
0
1 2000
2 2000
3 2000
0
1 250
2 350
3 450
4 750
0
1 – 19 0
20 2,750
8%
7.75%
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
Bond
A
B
C
D
E
5) Business finance / bond valuation (5) Bond Valuation spreadsheet
Maturity Coupon
10
25
30
95
100
5
6.5
3.75
1.75
0
Required return
7
4.5
5
8
6.5
Value
6) Complete the following table: (5)
Bond Maturity Coupon Price YTM
A
B
C
D
12
20
15
40
5
6.5
3.75
1.75
$987
$1,016
$1,000
$378
E 100 0 $176
The following are 2 points each (14)
7) What is the nominal rate of return if the real rate is 3%, the inflation premium is 6%, and the risk premium is 0??
8) What type of asset is in question 7?
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
9) A corporation is issuing a AA rated bond. The average return for a AA bond is 7%. The coupon rate is 9% with a 25 year maturity. What is the value of this bond?
10) If you can buy the bond in question 9 now at 1100, what would your YTM be?
11) If the company issuing the bond in question 9 undergoes some bad times and in 5 years the rating drops to BB, what will the value be in 5 years if the yield on BB bonds at that time is 10%?
12) If you waited and then purchased the above bond in 5 years for 850, what would your
YTM be then?
13) The bond in question 9 is callable in 10 years. The price is currently $1,100. If the call premium is the par value and one years interest what is the yield to call?
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
Chap 6 Web Exercise
Go to www.finra.org / investors / market data
For company data input your company’s ticker symbol
Does your company have bonds? If not, choose one of its competitors.
Click on the hyperlink to see “more bond information”
How many bonds are listed? (1)
Complete the next tasks. Click on the bonds hyperlink to find the number of bonds outstanding.
Highest coupon maturity Callable
Yes / no
Rating
S&P
Price Yield Outstanding bonds
Sort by coupon
Sort by maturity
Sort by price
Sort by yield
Content Coordinator: Dr. Lawrence Byerly

Chapter 06 BUA321
Go back to www.zacks.com (click on the todays market/ composite bond rates What are the yields on the following issues? (9pts)
Treasury Yields
Municipal AAA
Municipal A
Corporate AAA
Corporate A
3 month
5 year
30 year
5 year
10 year
20 year
5 year
10 year
20 year
5 year
10 year
20 year
5 year
10 year
20 year
Content Coordinator: Dr. Lawrence Byerly