Assume that you are considering the purchase of a 7-year bond with an annual coupon rate of 4.5%. The bond has face value of $1,000 and makes semiannual interest payments. If you require an 12.0% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?
Since, the bond pays semiannual interest payments, all the information given needs to be converted in terms of 6 months.
Duration = 7 years = 14 half-years
Interest per year = 1,000 * 4.5% = $45
Interest per half-year = 45/2 = $22.5
Required rate of return = 12% p.a. i.e., 6% per half-year.
Redemption value = $1,000
Therefore, the maximum price that can be paid for the bond = $651.44
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