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Home | Getting Started | Personal Finance | Q & A | Sample Portfolio | Glossary | About Us |
| Date: Monday 15th 2010f March 2010 02:19:21 PM |
|
Q & A - Philadelphia Electric Bond Value - 10/27/2009 |
| By: Hari Wibowo |
| Name: Connie |
| Website: |
| Date posted: Sun, Oct 11, 2009 |
|
Question:
Philadelphia Electric has many bonds trading on the New York Stock Exchange.
Suppose PhilEl’s bonds have identical coupon rates of 9.125% but that one
issue matures in 1 year, one in 7 years, and the third in 15 years. Assume
that a coupon payment was made yesterday. b. Suppose that the yield to maturity for all of these bonds changed instantaneously to 7%. What is the fair price of each bond now? c. Suppose that the yield to maturity for all of these bonds changed instantaneously again, this time to 9%. Now what is the fair price of each bond? d. Based on the fair prices at the various yields to maturity, is interest-rate risk the same, higher, or lower for longer- versus shorter-maturity bonds? |
| Answer: |
| Yield to maturity (YTM) is the return received of owning a bond from all payouts; coupon and capital gain (or loss). |
| b) With a coupon rate of 9.125% but (YTM) of 7%, this implies a capital loss on the bond. What the fair price of the bond means that the price currently it is trading. |
| The generic equation is: |
| c(1+r)-1 + c(1+r)-2 + c(1+r)-3 + c(1+r)-Y + B(1+r)-Y = P |
| Where: |
|
c = annual coupon payment (in dollars,
not a percent) Y = number of years to maturity B = par value P = purchase price |
| Plugging this equation for case 1 where bond will mature in one year, fair value of the bond (P) is equal to $ 101.986. |
| Plugging this equation for case 1 where bond will mature in seven years, fair value of the bond (P) is equal to $ 111.452. |
| Plugging this equation for case 1 where bond will mature in fifteen years, fair value of the bond (P) is equal to $ 119.354. |
| c. If the yield to maturity is set to 9%, then, |
|
Bond that will mature in one year, will have a
fair value (P) of $ 100.1147 Bond that will mature in seven years, will have a fair value (P) of $ 100.6291 Bond that will mature in fifteen years, will have a fair value (P) of $ 101.0076 |
| d. Interest rate risk for longer term maturity bond will always be higher than shorter term maturity one. This is because due to the nature variation of the economy which will result in interest rate variation. |
| Hari - Novice Investing |
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END |
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| Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding any securities. |
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