7. Valuing semiannual coupon bonds Aa Aa Bonds often pay a coupon twice a year.

Question

7. Valuing semiannual coupon bonds Aa Aa Bonds often pay a coupon twice a year. For the valuation of bonds that make semiannual payments, the number of periods doubles, whereas the amount of cash flow decreases by half. Using the values of cash flows and number of periods, the valuation model is adjusted accordingly. Assume that a $1,000,000 par value, semiannual coupon U.S. Treasury note with three years to maturity (YTM) has a coupon rate of 4%. The yield to maturity of the bond is 9.90%. Using this information and ignoring the other costs involved, calculate the value of the Treasury note: $535,517.24 $850,027.36 O $1,020,032.83 O $722,523.26 Based on your calculations and understanding of semiannual coupon bonds, complete the following statements: s price is expected to . The T-note described is selling at a when valuing, a semiannual coupon bond, the time period N in the present value formula used to calculate the price of the bond is treated in tems of periods

Explanation / Answer

The value of the treasury note can be calculated with the use of PV (present value) function of the EXCEL/Financial Calculator. The formula/function for calculating PV is PV(Rate,Nper,PMT,FV) where Rate = Yield To Maturity, Nper = Period, PMT = Interest Payment and FV = Face Value of Bonds

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Here, Rate = 9.90%/2 = 4.95%, Nper = 3*2 = 6, PMT = 1,000,000*4%/2 = $20,000 and FV = $1,000,000 [we use 2, since the bonds are semi-annual]

Using these values in the above function/formula for PV, we get,

Value of Treasury Note = PV(4.95%,6,20000,1000000) = $850,027.36 (which is Option B)

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Fill in the Blanks:

1) Increase, if interest rate remains constant, the value of treasury note issued at a discount will increase for each maturity period.

2) Discount, since the present value of the treasury note is less than the face value of the bonds, it clearly indicates that the note has been issued at a discount, that is, at a price lesser than the par value of the note. Further, the coupon rate of 4% is less than the interest rate prevailing in the market (9.90%) which again indicates that the note has been issued at a discount.

3) 6 month, since the compounding is done semi-annually.

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