1. To begin, assume that it is now January 1, 1993, and that each bond in Table 1 matures on December 31 of the indicated year. Also, suppose each bond has a par value of $1,000, each it had a 30-year maturity when it was issued, and the bonds currently have a 10 percent required nominal rate of return.

a. Why do bond coupon rates vary so much?

b. What would be the value of each bond if they had annual coupon payments?

C. TECO bonds, like virtually all bonds, actually pay interest semi-annually. what is each one the value of the bond under these conditions? Are the bonds currently selling at a discount or at a premium?

d. What is the effective annual rate of return implied by the values obtained in part c?

e. Would you expect a semi-annual payment bond to sell for a higher or lower price than an equivalent annual payment bond? Now look at the 5-year bond in Parts b and c. Are the prices shown consistent with your expectations? Explain.

2. Now, regardless of your answers to Question 1, suppose the 5-year bond sells for $800.00, the 15-year bond is selling for $865.49, and the 25-year bond is selling for $1,220.00.

(Note: Use these prices and assume semi-annual coupons for the rest of the questions.)

to. Explain the meaning of the term “yield to maturity”.

b. What is the nominal (as opposed to effective annual) yield to maturity (YTM) of each bond?

C. What is the effective annual YTM on each issuance?

d. When comparing bond yields to the yields of other securities, should nominal or effective YTM be used? Explain.

3. Suppose TECO has a second bond with twenty-five years to maturity (in addition to the one shown in Table 1), which has a coupon rate of 7 3/8 percent and a market price of $747.48. .

a. What is (1) the nominal yield and (2) the effective annual YTM of this bond?

b. What is the current yield on each of the 25-year bonds?

C. What is the expected price of each bond on January 1, 1994, and the 1993 capital gains yield, assuming no change in interest rates? (Hint: Remember that the nominal required rate of return on each bond is 10.18 percent.)

d. What would happen to the prices of each bond over time? (Again, assume constant future interest rates.)

e. What is the expected total return (percent) on each bond during 1993?

4. Consider the risk of bonds.

a. Explain the difference between interest rate (price) risk and reinvestment rate risk.

b. Which of the bonds listed in Table 1 has the greatest interest rate risk? Because?

Transcribed Image Text:

Note: Table 1 Partial Long-Term Debt Listing for TECO Energy Maturity Year Years to Maturity Face Amount Coupon Rate $ 48,000,000 4%% 1997 $32,000,000 8%% 2007 $100,000,000 12% % 2017 The terms stated here are modified slightly from the actual terms to simplify the case. 15 25 Note: Table 1 Partial Long-Term Debt Listing for TECO Energy Maturity Year Years to Maturity Face Amount Coupon Rate $ 48,000,000 4%% 1997 $32,000,000 8%% 2007 $100,000,000 12% % 2017 The terms stated here are modified slightly from the actual terms to simplify the case. 15 25

Answer rating: 100% (QA)

1 a Bond coupon rates vary based on several factors including the creditworthiness of the issuer prevailing market interest rates the time to maturity and the risk associated with the bond Higherrisk ... View the full answer