Question

an investor uses this simple risk model. she measures risk-free risk and industry risk in r and she accepts the market view for this r. she estimates that CF2 at T=3 for this bond will be about $90. should she purchase the bond, why or why not

Answer 1

The decision to purchase bond or not depends upon the discounted price value at which bond is issued and along with the coupon payments being made periodically. If the sum of present value of periodic coupon payments and present value of maturity value, in this case maturity value is assumed to be $ 90 and t=3. The maturity value needs to be discounted to present value along with the coupon payments on the basis of minimum acceptable rate of return. Generally, the maturity value is $ 100, so she shouldn't pruchase the bond.

However, if the sum of discounted maturity value and discounted coupon payments exceed the issue price, the bond should be pruchased as it will yield more.