Simon purchases a bond, newly issued by the Amalgamated Corporation, for $1, 000

Question

Simon purchases a bond, newly issued by the Amalgamated Corporation, for $1, 000. The bond pays $60 to its holder at the end of the first and second years and pays $1, 060 upon its maturity at the end of the third year. What are the principal amount, the term, the coupon rate, and the coupon payment for Simon's bond? After receiving the second coupon payment (at the end of the second year), Simon decides to sell his bond in the bond market. What price can he expect for his bond if the one-year interest rate at that time is J percent? 8 percent? 10 percent? Can you think of a reason that the price of Simon's bond after two years might fall below $1, 000, even though the market interest rate equals the coupon rate?

Explanation / Answer

a)Term = 3 years Coupon rate = Annual payment/Par value = 60/1000 = 6% Coupon payment = $60 Principal Amount = $1000 b) Price of the bond after 2nd year = Present value of future cash flows At 3% Price of the bond after 2nd year = 1060/(1.03) = 1029.13 At 8% Price of the bond after 2nd year = 1060/(1.08) = $981.48 At 10% Price of the bond after 2nd year = 1060/(1.1) = $963.64 c) Inflation, risk of investment, uncertainty of economy

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