Question

We buy a 12 year, 7% bond at the time that market rates are 6%. We intend to sell it in 2 years. At that time, the interest rates prevailing in the market are 4%. What do we sell the bond for in 2 years, and how much do we pay for it now? PLEASE USE FORMULA

Answer 1

The price of a bond is the PV of the cash flows resulting from
the bond when it is held till maturity. The expected cash
flows are:
*Maturity value of the bond.
*Periodic interest at the coupon rate, which is an annuity.
The discount rate to be used is the market rate of return.
Hence, the price of the bond if, it is to be bought now =
= 1000/1.06^12+70*(1.06^12-1)/(0.06*1.06^12) =	$ 1,083.84
Sale price after two years will be:
= 1000/1.04^10+70*(1.04^10-1)/(0.04*1.04^10) =	$ 1,243.33
Note: Annual payment of interest is assumed.
For half yearly payment the prices would be
Current price will be:
= 1000/1.03^24+35*(1.03^24-1)/(0.03*1.03^24) =	$ 1,084.68
Sale price after two years will be:
= 1000/1.02^20+35*(1.02^20-1)/(0.02*1.02^20) =	$ 1,245.27