You recently inherited from your late uncle a US government bond that matures De
ID: 1209762 • Letter: Y
Question
You recently inherited from your late uncle a US government bond that matures December 31, 2025. The bond has a face value of 20,000 USD, which is equal to its redemption value. It pays an annual interest of 8%, payable semi-annually (i.e. as 4%) on June 30 and December 31 of each year. Answer the following question by performing your calculations both analytically and by using the relevant Excel functions.
b) If the bond trades for 17,988 USD in the market on July 1, 2016, would you sell it? Shortly explain why.
Explanation / Answer
Given that:
The bond has a face value of 20,000 USD, which is equal to its redemption value. It pays an annual interest of 8%, payable semi-annually (i.e. as 4%) on June 30 and December 31 of each year.
Thus, the bond interest is $800 i.e. $20,000 × 4%
From 1st June 2016 to 31st Dec. 2025=19 intervals
To calculate the present value:
Coupon amount per interval = $800
Intervals = 19
Coupon rate = 4%
YTM = 5%
With the help of excel function calculate the present value.
PV (rate, nper, pmt, fv)
PV = (5%, 19, 800, 20000) = ($17,582.94)
Thus, the value of bond is $17,582.94
If the bond trades for $17,988 then the bonds can be sold. The reason behind is the value of the bond is $17,582.9. This implies that the bonds are traded at premium.
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