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Solution ManualBond Markets Analysis and Strategies 8th
Global_Edition
,2|Page
CHAPTER 1
(Questions are in bold print followed by answers.)
What is the cash flow of a 8-year bond that pays coupon interest semiannually, has a
coupon rate of 6%, and has a par value of $100,000?
The principal or par value of a bond is the amount that the issuer agrees to repay the
bondholder at the maturity date. The coupon rate multiplied by the principal of the bond
provides the dollar amount of the coupon (or annual amount of the interest payment). An 8-
year bond with a 6% annual coupon rate and a principal of $100,000 will pay semiannual
interest of (0.06/2)($100,000) = $3,000 for 8(2) = 16 periods. Thus, the cash flow is $3,000. In
addition to this periodic cash, the issuer of the bond is obligated to pay back the principal of
$100,000 at the time the last $3,000 is paid.
What is the cash flow of a 4-year bond that pays no coupon interest and has a par value of
$1,000?
There is no periodic cash flow as found in the previous problem. Thus, the only cash flow will be
the principal payment of $1,000 received at the end of six years. This type of cash flow resembles
a zero-coupon bond. The holder of such a bond realizes interest by buying the bond substantially
below its principal value. Interest is then paid at the maturity date, with the exact amount being
the difference between the principal value and the price paid for the bond.
Give three reasons why the maturity of a bond is important.
There are three reasons why the maturity of a bond is important. First, the maturity gives the
time period over which the holder of the bond can expect to receive the coupon payments and
the number of years before the principal will be paid in full. Second, the maturity is important
because the yield on a bond depends on it. The shape of the yield curve determines how the
maturity affects the yield. Third, the price of a bond will fluctuate over its life as yields in the
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market change. The volatility of a bond’s price is dependent on its maturity. More specifically,
with all other factors constant, the longer the maturity of a bond, the greater the price volatility
resulting from a change in market yields.
Explain whether or not an investor can determine today what the cash flow of a floating-rate
bond will be.
Floating-rate bonds are issues where the coupon rate resets periodically based on a general
formula equal to the reference rate plus the quoted margin. The reference rate is some index
subject to change. The exact change is unknown and uncertain. Thus, an investor cannot
determine today what the cash flow of a floating-rate bond will be in the future.
Suppose that coupon reset formula for a floating-rate bond is: 1-month LIBOR + 130 basis
points.
What is the reference rate?
The reference rate is the 1-month LIBOR.
What is the quoted margin?
The quoted margin is the 130 basis points (or 1.30%).
Suppose that on coupon reset date that 1-month LIBOR is 2.4%. What will the coupon rate
be for the period?
The coupon reset formula is: 1-month LIBOR + 130 basis points. So, if 1-month LIBOR on the
coupon reset date is 2.4%, the coupon rate is reset for that period at 2.40% + 1.30% = 3.70%..
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What is a deferred coupon bond?
Deferred-coupon bonds are coupon bonds that let the issuer avoid using cash to make interest
payments for a specified number of years. There are three types of deferred-coupon structures:
(1) deferred-interest bonds, (2) step-up bonds, and (3) payment-in-kind bonds.
What is meant by a linker?
A linker is a bond whose interest rate is tied to the rate of inflation. The U.S. Treasury issues linkers,
and they are referred to as Treasury Inflation Protection Securities (TIPS).
Answer the below questions.
What is meant by an amortizing security?
The principal repayment of a bond issue can be for either the total principal to be repaid at
maturity or for the principal to be repaid over the life of the bond. In the latter case, there is a
schedule of principal repayments. This schedule is called an amortization schedule. Loans that
have this amortizing feature are automobile loans and home mortgage loans. There are securities
that are created from loans that have an amortization schedule. These securities will then have a
schedule of periodic principal repayments. Such securities are referred to as amortizing securities.
Why is the maturity of an amortizing security not a useful measure?
For amortizing securities, investors do not talk in terms of a bond’s maturity. This is because the
stated maturity of such bonds or securities only identifies when the final principal payment will
be made. For an amortized security, the repayment of the principal is made through multiple
payments over its maturity and not just at the end of its term to maturity. Thus, the maturity is
not a useful measure in terms of identifying when the principal is repaid.
Solution ManualBond Markets Analysis and Strategies 8th
Global_Edition
,2|Page
CHAPTER 1
(Questions are in bold print followed by answers.)
What is the cash flow of a 8-year bond that pays coupon interest semiannually, has a
coupon rate of 6%, and has a par value of $100,000?
The principal or par value of a bond is the amount that the issuer agrees to repay the
bondholder at the maturity date. The coupon rate multiplied by the principal of the bond
provides the dollar amount of the coupon (or annual amount of the interest payment). An 8-
year bond with a 6% annual coupon rate and a principal of $100,000 will pay semiannual
interest of (0.06/2)($100,000) = $3,000 for 8(2) = 16 periods. Thus, the cash flow is $3,000. In
addition to this periodic cash, the issuer of the bond is obligated to pay back the principal of
$100,000 at the time the last $3,000 is paid.
What is the cash flow of a 4-year bond that pays no coupon interest and has a par value of
$1,000?
There is no periodic cash flow as found in the previous problem. Thus, the only cash flow will be
the principal payment of $1,000 received at the end of six years. This type of cash flow resembles
a zero-coupon bond. The holder of such a bond realizes interest by buying the bond substantially
below its principal value. Interest is then paid at the maturity date, with the exact amount being
the difference between the principal value and the price paid for the bond.
Give three reasons why the maturity of a bond is important.
There are three reasons why the maturity of a bond is important. First, the maturity gives the
time period over which the holder of the bond can expect to receive the coupon payments and
the number of years before the principal will be paid in full. Second, the maturity is important
because the yield on a bond depends on it. The shape of the yield curve determines how the
maturity affects the yield. Third, the price of a bond will fluctuate over its life as yields in the
,3|Page
market change. The volatility of a bond’s price is dependent on its maturity. More specifically,
with all other factors constant, the longer the maturity of a bond, the greater the price volatility
resulting from a change in market yields.
Explain whether or not an investor can determine today what the cash flow of a floating-rate
bond will be.
Floating-rate bonds are issues where the coupon rate resets periodically based on a general
formula equal to the reference rate plus the quoted margin. The reference rate is some index
subject to change. The exact change is unknown and uncertain. Thus, an investor cannot
determine today what the cash flow of a floating-rate bond will be in the future.
Suppose that coupon reset formula for a floating-rate bond is: 1-month LIBOR + 130 basis
points.
What is the reference rate?
The reference rate is the 1-month LIBOR.
What is the quoted margin?
The quoted margin is the 130 basis points (or 1.30%).
Suppose that on coupon reset date that 1-month LIBOR is 2.4%. What will the coupon rate
be for the period?
The coupon reset formula is: 1-month LIBOR + 130 basis points. So, if 1-month LIBOR on the
coupon reset date is 2.4%, the coupon rate is reset for that period at 2.40% + 1.30% = 3.70%..
, 4|Page
What is a deferred coupon bond?
Deferred-coupon bonds are coupon bonds that let the issuer avoid using cash to make interest
payments for a specified number of years. There are three types of deferred-coupon structures:
(1) deferred-interest bonds, (2) step-up bonds, and (3) payment-in-kind bonds.
What is meant by a linker?
A linker is a bond whose interest rate is tied to the rate of inflation. The U.S. Treasury issues linkers,
and they are referred to as Treasury Inflation Protection Securities (TIPS).
Answer the below questions.
What is meant by an amortizing security?
The principal repayment of a bond issue can be for either the total principal to be repaid at
maturity or for the principal to be repaid over the life of the bond. In the latter case, there is a
schedule of principal repayments. This schedule is called an amortization schedule. Loans that
have this amortizing feature are automobile loans and home mortgage loans. There are securities
that are created from loans that have an amortization schedule. These securities will then have a
schedule of periodic principal repayments. Such securities are referred to as amortizing securities.
Why is the maturity of an amortizing security not a useful measure?
For amortizing securities, investors do not talk in terms of a bond’s maturity. This is because the
stated maturity of such bonds or securities only identifies when the final principal payment will
be made. For an amortized security, the repayment of the principal is made through multiple
payments over its maturity and not just at the end of its term to maturity. Thus, the maturity is
not a useful measure in terms of identifying when the principal is repaid.
