Question

Lucy Lampkin wants to purchase a bond with a face value of $7,000 and a bond rate of 8% per year, payable at 4% semiannually. The bond has a remaining life of 5 years. If Lucy wants to earn at least 7% per year compounded semiannually, what is the maximum price she would be willing to pay to purchase the bond?

$________________

Answer 1

Semi-annual coupon payment ($) = Face value x semi-annual Coupon rate = 7,000 x 4% = 280

Semi-annual market rate = 7% / 2 = 3.5%

Term to maturity = 5 years = (5 x 2) = 10 coupon periods

Bond price ($) = Present value of future coupon payments + Present value of redemption amount (Face value)

= 280 x PVIFA(3.5%, 10) + 7,000 x PVIF(3.5%, 10)

= 280 x 8.3166** + 7,000 x 0.7089** = 2,328.65 + 4,962.3

= 7,290.95

**PVIFA(r%, N) = [1 - (1 + r)^-N] / r

PVIFA(3.5%, 10) = [1 - (1.035)^-10] / 0.035 = (1 - 0.7089) / 0.035 = 0.2911 / 0.035 = 8.3166

PVIF(r%, N) = (1 + r)^-N

PVIF(3.5%, 10) = (1.035)^-10 = 0.7089