Self-Test Problems (Solutions Appear in Appendix A)
The Pennington Corporation issued a new series of bonds on January 1, 1979. The bonds were
sold at par ($1,000), have a 12 percent coupon, and mature in 30 years, on December 31, 2008.
Coupon payments are made semiannually (on June 30 and December 31).
a.What was the YTM of Pennington’s bonds on January 1, 1979?
b.What was the price of the bond on January 1, 1984, 5 years later, assuming that the level of
interest rates had fallen to 10 percent?
c.Find the current yield and capital gains yield on the bond on January 1, 1984, given the price
as determined in part b.
d.On July 1, 2002, Pennington’s bonds sold for $916.42. What was the YTM at that date?
e.What were the current yield and capital gains yield on July 1, 2002?
f.Now, assume that you purchased an outstanding Pennington bond on March 1, 2002, when
the going rate of interest was 15.5 percent. How large a check must you have written to com-
plete the transaction? This is a hard question! (Hint: PVIFA7.75%,13 8.0136 and
PVIF7.75%,130.3789.)
The Vancouver Development Company has just sold a $100 million, 10-year, 12 percent bond
issue. A sinking fund will retire the issue over its life. Sinking fund payments are of equal
amounts and will be made semiannually,and the proceeds will be used to retire bonds as the pay-
ments are made. Bonds can be called at par for sinking fund purposes, or the funds paid into the
sinking fund can be used to buy bonds in the open market.
a.How large must each semiannual sinking fund payment be?
b.What will happen, under the conditions of the problem thus far, to the company’s debt ser-
vice requirements per year for this issue over time?
c.Now suppose Vancouver Development set up its sinking fund so thatequal annual amounts,
payable at the end of each year, are paid into a sinking fund trust held by a bank, with the pro-
ceeds being used to buy government bonds that pay 9 percent interest. The payments, plus
accumulated interest, must total $100 million at the end of 10 years, and the proceeds will be
used to retire the bonds at that time. How large must the annual sinking fund payment be
now?
d.What are the annual cash requirements for covering bond service costs under the trusteeship
arrangement described in part c? (Note: Interest must be paid on Vancouver’s outstanding
bonds but not on bonds that have been retired.)
e.What would have to happen to interest rates to cause the company to buy bonds on the open
market rather than call them under the original sinking fund plan?
Problems
Callaghan Motors’ bonds have 10 years remaining to maturity. Interest is paid annually, the
bonds have a $1,000 par value, and the coupon interest rate is 8 percent. The bonds have a yield
to maturity of 9 percent. What is the current market price of these bonds?
Wilson Wonders’ bonds have 12 years remaining to maturity. Interest is paid annually, the
bonds have a $1,000 par value, and the coupon interest rate is 10 percent. The bonds sell at a
price of $850. What is their yield to maturity?
Thatcher Corporation’s bonds will mature in 10 years. The bonds have a face value of $1,000 and
an 8 percent coupon rate, paid semiannually. The price of the bonds is $1,100. The bonds are
callable in 5 years at a call price of $1,050. What is the yield to maturity? What is the yield to call?
Heath Foods’ bonds have 7 years remaining to maturity. The bonds have a face value of $1,000
and a yield to maturity of 8 percent. They pay interest annually and have a 9 percent coupon
rate. What is their current yield?
Nungesser Corporation has issued bonds that have a 9 percent coupon rate, payable semiannu-
ally. The bonds mature in 8 years, have a face value of $1,000, and a yield to maturity of 8.5 per-
cent. What is the price of the bonds?
4–5
BOND VALUATION; FINANCIAL
CALCULATOR NEEDED
4–4
CURRENT YIELD
4–3
YIELD TO MATURITY AND CALL;
FINANCIAL CALCULATOR
NEEDED
4–2
YIELD TO MATURITY; FINANCIAL
CALCULATOR NEEDED
4–1
BOND VALUATION
ST–2
SINKING FUND
ST–1
BOND VALUATION
Problems 183
Bonds and Their Valuation 179
