Sally Simmons has been a client of Bill Bronson, a local broker, for years. Bill

Question

Sally Simmons has been a client of Bill Bronson, a local broker, for years. Bill has offered to sell Sally a bond for $795. Bill believes the bond should yield 8%.

Always a wise investor, Sally heads home to think it over. She knows that the bond has twelve years left until maturity and pays an annual coupon rate of 5%. Using annual analysis, what does Sally conclude about this bond?

Select one:

a. The bond is overvalued; she should not purchase it.

b. The bond is undervalued; she should not purchase it.

c. The bond is undervalued; she should purchase it.

d. The bond is overvalued; she should purchase it.

Explanation / Answer

Correct Option : a. The bond is overvalued; she should not purchase it.

Present value of the bond = Annual Coupon x PVIFA 8%, 12 years + Face Value x PVIF 8%, 12 years

= $1,000 x 5% x 7.5361 + $1,000 x 0.3971 = $ 773.91

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