An investor is considering buying a 20-year corporate bond. The bond has a face

Question

An investor is considering buying a 20-year corporate bond. The bond has a face value of $1000 and pays 6% interest per year in two semiannual payments. Thus the purchaser of the bond would receive $30 every 6 months and in addition he would receive $1000 at the end of 20 years, along with the last $30 interest payment. If the investor thought he should receive 8% interest, compounded semiannually, how much would he be willing to pay for the bond? Three mutually exclusive alternatives are being considered. Each alternative ha a 20-year useful life with no salvage value. The minimum attractive rate of return is 7%. Which alternative should be selected?

Explanation / Answer

solution 5:

YTM = coupon interest + face value - redemption /n /F.V + redemption /2

Since the redemption happened at the face value hence the YTM = 3% per year

If 8 % semi annually then the bond amount would be

3% = 40 + 1000- X/40 / 1000 +x/2

.03 = 3200 +2000 - 2x/40000+40X

1200+1.2X = 3200 +2000-2X

3.2X = 4000

x = 4000/3.2

The bond value would be $1250

solution 6 :

We need to find the present value of the future cash flows

Project A

Project B:

Project C:

Hence project B is better

Year CAsh flow Discount 8%20 YEARS Cash flow present value 0 -50000 1 -50000 1-20 5093 9.818 50003.58 Present value 3.583

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