•Assume that the company that you selected for the Module 1 SLP has a bond outst
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Question
•Assume that the company that you selected for the Module 1 SLP has a bond outstanding that matures in 20 years and has a coupon rate of 6.5%. The par value of the bond is $1,000. •If the yield to maturity is 8% and the bond pays interest on an annual basis, what’s the current price of the bond? Is the bond selling for a premium or discount? How can you tell? •If the yield to maturity is 8% but the bond pays interest on a semi-annual basis instead of an annual basis, what’s the current price of the bond? Is it different from the value when using annual compounding? Explain. •Now, assume that the economy enters into a recession and interest rates fall. The bond’s yield to maturity is now 5%. What’s the bond’s new price? How does the price compare with your answer in part a? Why did the bond’s value change? •A bond matures in ten years and is currently selling for $1,125. The bond pay interest annually, has a par value of $1,000, and a yield to maturity of 10.75%. What’s the bond’s current yield?
Explanation / Answer
1. Bond Price = 65 x PVAF(8%, 20years) + 1,000 x PVAF(8%, 20 years) = (65 x 9.818) + (1,000 x 0.2145) = $852.73
2. Bond is trading at a discount because the Bond price is less than its face value and also Interest rates are more than the coupon rate.
3. Bond Price = 32.5 x PVAF(4%, 40periods) + 1,000 x PVAF(4%, 40periods) = (32.5 x 19.793) + (1,000 x 0.2083) = $851.55
4. Yes, in semi-annual compounding price is slightly different as calculated in annual compounding.
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