CP

Explain the difference between the yield to maturity and the yield to call.

How does a bond’s current yield differ from its total return?

Could the current yield exceed the total return?

Bonds with Semiannual Coupons

Although some bonds pay interest annually, the vast majority actually pay interest

semiannually. To evaluate semiannual payment bonds, we must modify the valuation

model (Equation 4-1) as follows:

1. Divide the annual coupon interest payment by 2 to determine the dollars of inter-
   est paid each six months.


2. Multiply the years to maturity, N, by 2 to determine the number of semiannual pe-
   riods.


3. Divide the nominal (quoted) interest rate, rd, by 2 to determine the periodic (semi-
   annual) interest rate.
   By making these changes, we obtain the following equation for finding the value of
   a bond that pays interest semiannually:

(4-1a)

To illustrate, assume now that MicroDrive’s bonds pay $50 interest each six months

rather than $100 at the end of each year. Thus, each interest payment is only half as

large, but there are twice as many of them. The coupon rate is thus “10 percent, semi-

annual payments.” This is the nominal, or quoted, rate.^9

VB
 a

2N

t
 1

INT/2

(1rd/2)t



M

(1rd/2)2N

Bonds with Semiannual Coupons 165

Drinking Your Coupons

In 1996 Chateau Teyssier, an English vineyard, was looking
for some cash to purchase some additional vines and to mod-
ernize its production facilities. Their solution? With the as-
sistance of a leading underwriter, Matrix Securities, the vine-
yard issued 375 bonds, each costing 2,650 British pounds.
The issue raised nearly 1 million pounds, or roughly $1.5
million.
What makes these bonds interesting is that, instead of
getting paid with something boring like money, these
bonds paid their investors back with wine. Each June until
2002, when the bond matured, investors received their

“coupons.” Between 1997 and 2001, each bond provided six

cases of the vineyard’s rose or claret. Starting in 1998 and

continuing through maturity in 2002, investors also received

four cases of its prestigious Saint Emilion Grand Cru. Then,

in 2002, they got their money back.

The bonds were not without risk. The vineyard’s owner,

Jonathan Malthus, acknowledges that the quality of the

wine, “is at the mercy of the gods.”

Source:Steven Irvine, “My Wine Is My Bond, and I Drink My Coupons,”

Euromoney,July 1996, 7. Reprinted by permission.

(^9) In this situation, the nominal coupon rate of “10 percent, semiannually,” is the rate that bond dealers, cor-
porate treasurers, and investors generally would discuss. Of course, the effective annual ratewould be higher
than 10 percent at the time the bond was issued:
Note also that 10 percent with annual payments is different than 10 percent with semiannual payments.
Thus, we have assumed a change in effective rates in this section from the situation in the preceding section,
where we assumed 10 percent with annual payments.
EAR
EFF%
a 1 
rNom
mb
m
 1
a 1 0.10 2 b
2
 1
(1.05)^2  1
10.25%.

Bonds and Their Valuation 161