Question

A bond has 6 years remaining to maturity and pays annual coupons at a rate of 5%. It has an annual yield-to-maturity of 7% and a face value of £1,000.

1. What is the current price of the bond?                

ii. If market interest rates applicable to this type of bond are currently at 7% per year, would the price that you computed in be a fair price to pay for the bond? Explain why.

Answer 1

Solution :-

Time to Maturity (n) = 6

Coupon Rate = 5%

Face Value = $1,000

Coupon Amount = $1,000 * 5% = $50

Price of Bond = $50 * PVAF ( 7% , 6 ) + $1,000 * PVF ( 7% , 6 )

= ( $50 * 4.766 ) + ( $1,000 * 0.666 )

= $238.33 + $666.34

= $904.67

(ii) Yes , If market interest rates applicable to this type of bond are currently at 7% per year, The price that you computed in be a fair price to pay for the bond , as the YTM used in first part is just a interest rate or we say required return on the bond

If there is any doubt please ask in comments

Thank you please rate