4. Determining Interest and Approximate Bond Value. Assume that three years ago,

Question

4. Determining Interest and Approximate Bond Value. Assume that three years ago, you purchased a corporate bond that pays 9.5 percent. The purchase price was $1,000. Also assume that three years after your bond investment, comparable bonds are paying 8 percent.

a.   What is the annual dollar amount of interest that you will receive from your bond investment?

b.  Assuming that comparable bonds are paying 8 percent, what is the approximate dollar price for which you could sell your bond?

c.  explain why your bond increased or decreased in value

Explanation / Answer

Answer:a Calculation of the annual dollar amount of interest that will receive from your bond investment: =$1000*9.5%

=$95

Answer: b. Calculation of the approximate dollar price for which you could sell your bond:We are offering an additional 1.5% in interest for the same term. That means with our bond you get an extra $15 a year over the interest you get with the comparable bond (we assume the remainder of our bond's term is equal to the term of the new bond we would get paying 8%)

15 a year for x number of years is worth what today? We need to know the remaining number of years to place a present value on the extra $15 per year.

If you knew the duration of the bond (D), you could say that the price is approximately
1000*(1+D*1.5%)
Duration is the price elasticity with respect to interest rates.

Answer: c This bond increased in value because you owned a bond with a fixed interest rate of 9.5 percent during a time period when interest rates in the economy were declining.

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