1.2.

An investor has two bonds in his portfolio that have a face value of $1,000 and pay a 12% annual coupon. Bond L matures in 13 years, while Bond S matures in 1 year. a. What will the value of the Bond L be if the going interest rate is 7%, 8%, and 13%? Assume that only one more interest payment is to be made on Bond S at its maturity and that 13 more payments are to be made on Bond L. Round your answers to the nearest cent. 7% 8% 13% Bond L $ $ Bond S b. Why does the longer-term bond's price vary more than the price of the shorter-term bond when interest rates change? I. Long-term bonds have greater interest rate risk than do short-term bonds. II. The change in price due to a change in the required rate of return decreases as a bond's maturity increases. III. Long-term bonds have lower interest rate risk than do short-term bonds. IV. Long-term bonds have lower reinvestment rate risk than do short-term bonds. V. The change in price due to a change in the required rate of return increases as a bond's maturity decreases. -Select- v Pelzer Printing Inc. has bonds outstanding with 9 years left to maturity. The bonds have an 8% annual coupon rate and were issued 1 year ago at their par value of $1,000. However, due to changes in interest rates, the bond's market price has fallen to $910.40. The capital gains yield last year was -8.96%. a. What is the yield to maturity? Do not round intermediate calculations. Round your answer to two decimal places. % b. For the coming year, what are the expected current and capital gains yields? (Hint: Refer to Footnote 6 for the definition of the current yield and to Table 7.1.) Do not round intermediate calculations. Round your answers to two decimal places. Expected current yield: % Expected capital gains yield: % c. Will the actual realized yields be equal to the expected yields if interest rates change? If not, how will they differ? I. As rates change they will cause the end-of-year price to change and thus the realized capital gains yield to change. As a result, the realized return to investors will differ from the YTM. II. As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors will differ from the YTM. III. As long as promised coupon payments are made, the current yield will not change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors should equal the YTM. IV. As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors should equal the YTM. V. As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will not cause the price to change and as a result, the realized return to investors should equal the YTM. -Select- TABLE 7.1 Calculation of Current Yields, Capital Gains Yields, and Total Returns for 5%, 8%, and 11% Coupon Bonds When the Market Rate Remains Constant at 8% 5% COUPON BOND 8% COUPON BOND 11% COUPON BOND % Number of Years Until Maturity Expected Current Yield Expected Capital Gains Yield Expected Total Return Expected Current Yield" Expected Capital Gains Yield Expected Total Return Expected Expected Current Capital Gains Yield" Yield Expected Total Return Price Price Price 1.3% 8.096 -0.8% % -0.8 8.0 -0.9 8.0 -1.0 8.0 8.0 -1.1 8.0 9.2 -1.2 8.0 -1.3 8.0 -1.4 8.0 -1.5 8.0 -1.7 8.0 15 $ 743.22 6.7% 8.0% $1,000.00 8.096 0.0% 8.0% $1,256.78 8.896 14 752.67 6.6 1.4 8.0 1,000.00 8.0 0.0 8.0 1,24733 8.8 13 762.89 6.6 1.4 8.0 1,000.00 8.0 0.0 8.0 1,237.11 8.9 12 773.92 6.5 1.5 8.0 1,000.00 8.0 0.0 8.0 1,226.08 9.0 11 785.83 6.4 1.6 8.0 1,000.00 0.0 8.0 1,214.17 9.1 10 798.70 6.3 1.7 8.0 1,000.00 8.0 0.0 8.0 1,201.30 9 812.59 6.2 1.8 8.0 1,000.00 8.0 0.0 8.0 1,187 41 9.3 8 827.60 6.0 2.0 8.0 1,000.00 8.0 0.0 8.0 1,172.40 9.4 7 843.81 5.9 2.1 8.0 1,000.00 8.0 0.0 8.0 1,156.19 9.5 6 861.31 5.8 2.2. 8.0 1,000.00 8.0 0.0 8.0 1,138.69 9.7 5 880.22 5.7 2.3 8.0 1,000.00 8.0 0.0 8.0 1,119.78 9.8 4 900.64 5.6 2.4 8.0 1,000.00 8.0 0.0 8.0 1,099.36 10.0 3 922.69 5.4 2.6 8.0 1,000.00 8.0 0.0 8.0 1,077.31 10.2 2 946.50 5.3 2.7 8.0 1,000.00 8.0 0.0 8.0 1,053.50 10.4 1 972.22 5.1 2.9 8.0 1,000.00 8.0 0.0 8.0 1,027.78 10.7 0 1,000.00 1,000.00 1,000.00 Notes: Using a financial calculator, the price of each bond is calculated by entering the data for NL/YR, PMT, and FV, then solving for PV = the bond's value. The expected current yield is calculated as the annual interest divided by the price of the bond. The expected capital gains yield is calculated as the difference between the end-of-year bond price and the beginning-of-year bond price divided by the beginning-of-year bond price. The expected total return is the sum of the expected current yield and the expected capital gains yield. -1.8 8.0 -2.0 8.0 -2.2 8.0 -2.4 8.0 -2.7 8.0