INSTRUCTOR: Mr. Konstantinos Kanellopoulos, MSc (L.S.E.), M.B.A.

COURSE: FIN-210-50-S13 Finance

SEMESTER: II, 2013

Tutorial 3 – for tutor

INSTRUCTIONS

Students are required to study the following questions and problems indicated and to be
able to solve them by themselves.

Although this is not a required part of a coursework, the purpose of the tutorial is
twofold: to help the student understand the methodology for solving the problems and to
help him/her prepare for the courseworks and/or exams. The utilisation of this resource
can be maximised depending on the time and effort each individual student devotes.

Konstantinos Kanellopoulos
2nd April 2013
Valuation Concepts

Question 1
The rate of return you would get if you bought a bond and held it to its maturity date is
called the bond’s yield to maturity. If interest rates in the economy rise after a bond has
been issued, what will happen to the bond’s price and to its YTM? Does the length of
time to maturity affect the extent to which a given change in interest rates will affect the
bond’s price?

Answer 1
If interest rates increase after a bond has been issued, the market value of the bond will
decrease. Investors can earn the higher yields on alternative investments with similar
risk, and thus they will only buy previously issued bonds if their prices have declined to
the point where the yields to maturity on the outstanding bonds are equal to the yields
on similar risk alternative investments. Everything else equal, the market prices of
bonds with longer terms to maturity will change more than the prices of bonds with
shorter terms to maturity.