Question

Jim Busby calls his broker to inquire about purchasing a bond of Disk Storage Systems. His broker quotes a price of $1,170. Jim is concerned that the bond might be overpriced based on the facts involved. The $1,000 par value bond pays 11 percent interest, and it has 15 years remaining until maturity. The current yield to maturity on similar bonds is 9 percent.

a. Calculate the present value of the bond. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
  

Present value?????

  
b. Do you think the bond is overpriced?
  

	Yes
	No

Answer 1

Present value of bond –

Present value of face value + present value of interest

Yield to maturity = 9%

Period, n = 15 years

Present value of face value = $1,000 x (P/F, 9%, 15)

= $1,000 x 0.2745 = $275

Present value of interest payments

Annual interest = 1,000 x 11% = $110

PV = 110 x (P/A, 9%, 15) = 110 x 8.061

PV of interest payments = $887

Price of bond = $275 + $887 = $1,162

The price of the bond ($1,162) computed above is almost equal to the price ($1,170) quoted by the broker.

No, the bond is not overpriced.

Explanation: the computed price of bond is $1,162 which is almost equal to the price quoted by thebroker, hence, the bond is not overpriced.