Question

Suppose that Starbucks Corporation (SBUX) issued a two-year bond with a face value of $1000 and an annual coupon rate of 6%. The yield to maturity on this bond when it was issued was 5%.

1. What was the price of this bond when it was issued?
2. Does this bond trade at a discount, at par, or at a premium?
3. Assuming the yield to maturity remains constant, what is the price of the bond immediately before it makes its first coupon payment?

Answer 1

Solution:

a)Calculation of Price of bond

Price of bond=Coupon Payment/(1+r)^n+(Coupon payment+Par value)^n

Coupon payment=$1000*6%=$60

n=Number of years

r=Yield to maturity=5%

Price of bond=$60(1+.05)^1+($60+$1000)/(1+.05)^2

=$57.143+$961.451

=$1018.60

b)Since the price of bond($1018.60) is higher than its face value($1000),hence bond is trade at premium.

c)Price of the bond immediately before it makes its first coupon payment means price of bond at the end of year 1

In this case first coupon payment is not required to be discount.And the coupon payment and face value at year end 2 is require to discount for 1 year only.

Price=Coupon payment+(Coupon payment+Face value)/1+r)

=$60+($60+$1000)/(1+.05)

=$1069.52