For part (a) of this question, in order to work out the value of Bond M I unders
ID: 2626016 • Letter: F
Question
For part (a) of this question, in order to work out the value of Bond M I understand that it involves two annuities.
I am confused at the solutions though..could someone explain to me why the PVA is being multiplied by 1200/(1.05^12) and 1500/(1.05^28)? In particullar, where did the numbers 12 and 28 come from?
Many thanks!!
GDD PLC currently has two different bonds in issue. Bond M has face value 20,000 and matures in 20 years. It makes no payments in the first 6 year. In the subsequent 8 years, it pays pound 1,200 every 6 months and finally pays pound 1,500 every 6 months for the last 6 years. Bond N has the same face value and maturity but makes no coupon payments. If the required return on these two bonds is 10% compounded semi-annually, compute the prices for each bond issue. A company is contemplating a bond issue and debating whether or not to include a call provision. What are the costs and benefits from including a call provision? How would these answers change if you were considering a put provision? The price of any bond (or financial instrument) is the PV of the future cash flows. Even though Bond M makes varying coupon payments, to find the price of the bond, we just find the PV of the cash flows. The PV of the cash flows for Bond M is: where PVA (z, m) is the present value of a pound 1 annuity at rate z and with lifetime m periods. Bond N is a zero coupon bond with a 20,000 par value; therefore, the price of the bond is the PV of the face value;Explanation / Answer
The PVA(0.05,16) is not the present value its the value of the cash flows coming in those 8 years after those initial 6 years.So to get the present value we need to account for those first 6 years where there are no cash flows as the rate is 5% semi annually for 6 years i.e, 12 months the factor would be 1.05^12 as for the 1200 the solution says PVA is present value of 1euro so we mutiply by 1200 .Same is the case with 28 the only difference is now the years would be 8+6=14 years i.e, 28 months.
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