Question

Bond valuation​) You own a 10​-year, ​$1000 par value bond paying 8 percent interest annually. The market price of the bond is ​$750​, and your required rate of return is 14 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

Bond Details :

Par value = $1000

Time to maturity = 10 years

Interest rate = 8% annually

a) Compute the bond’s expected rate of return

The formula is

Expected rate of return = (Interest + Market price - Par value)/ Par value

Interest = 0.08*1000= $80

Market price = $750

Par value = $1000

Expected rate of return = (80 + 750 - 1000)/ 1000 = -17%

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

Price of bond = (70/0.14)[1-(1/1.14¹⁰)] + $1000/1.14¹⁰

Price of bond = $365.128 + $269.743= $634.871

c) Should you sell the bond or continue to own it

As the present value of the bond is less than the par value of the bond, we should sell the bond