Question

Assume a bond with a face value of $1000 with annual interest of 10% and period of five years. Present the various payments based on semi annual payment and quarterly repayment. Which payments would you prefer if you were a bond/debt security investor?

Answer 1

Given,  

Face value of the bond = $1000

Annual interest rate =10%

Period of Maturity. = 5 years

1) PAYMENT BASED ON SEMI ANNUAL INTEREST PAYMENT:-

Number of periods = 5 years × 2 = 10

Semi- annual interest rate = 10% × 6/12 = 5%

Present value of future interest payments =$1000 × 5%× Present value of annuity factor(5% , 10)

=$50 × 7.7217

= $386.085.

2)PAYMENT BASED ON QUARTERLY INTEREST PAYMENT:-

Number of periods = 5 years × 4 = 20

Quarterly interest rate = 10% × 3/12= 2.5 %

Present value of future interest payments

= $1000 × 2.5% × Present value of annuity

factor (2.5% , 20).

=$25 × 15.5892

=$389.730

Therefore, If I am bond/security investor then , I would like to prefer interest payments on QUARTERLY basis.because of present value of the interest payments on Quarterly basis is more than the semi- annual basis (i.e $389.730 > $386.085).