Question

You own a ​10-year, ​$1000 par value bond paying 8percent interest annually. The market price of the bond is ​$925​, and your required rate of return is 11 percent.

a. Compute the​ bond's expected rate of return.

b. Determine the value of the bond to​ you, given your required rate of return.

c. Should you sell the bond or continue to own​ it?

Answer 1

a). To find the bond's return, we need to put the following values in the financial calculator:

N = 10;

PV = -925;

PMT = 8%*1000 = 80;

FV = 1000;

Press CPT, then I/Y, which gives us 9.18

So, Bond's Return = 9.18%

b). Bond's Market Value = PV of Coupon Payment + PV of Maturity Value

= [Periodic Coupon Payment * {(1 - (1 + r)^-n) / r}] + [Face Value / (1 + r)^n]

= [{8%*$1,000} * {(1 - (1 + 0.11)^-(10)) / (0.11)}] + [$1,000 / {1 + (0.11)}^(10)]

= [$80 * {0.6478 / 0.11}] + [$1,000 / 2.8394]

= [$80 * 5.8892] + $352.18

= $471.14 + $352.18 = $823.32

c). You should sell the bond, as its value to you is lower than the current market price of the bond.