Question

2. Midland Utilities has a bond issue outstanding that will mature to its$1,000 par value in 13 years. The bond has a coupon interest rate of 13​% and pays interest annually. a.  Find the value of the bond if the required return is​ (1) 13​%, ​(2) 17​%, and​ (3) 10​%. b.  Use your finding in part a to discuss the relationship between the coupon interest rate on a bond and the required return and the market value of the bond relative to its par value. c.  What two possible reasons could cause the required return to differ from the coupon interest​ rate?

Answer 1

Par Value = 1000
Maturity = 13 years
Coupon = 13%*1000 = 130
Required Rate = 13%

1) Price of bond at 13% YTM = 1000
Because when YTM and coupon rate are same then bond is sold at par value.

2) Price of bond at 17% YTM = PV of Coupons + PV of Par Value = 130*(1-(1+17%)^-13)/17% + 1000/(1+17%)¹³ = 795.27

3)   Price of bond at 10% YTM = PV of Coupons + PV of Par Value = 130*(1-(1+10%)^-13)/10% + 1000/(1+10%)¹³ = 1213.10

b)When coupon rate and YTM are same price and par value are same.
When Coupon rate less than YTM price of bond is less.
When coupon rate more than YTM price of bond is more.

c) YTM could be different from coupon rate because
a) The risk of company would have increased or crediting rating would have decreased.
b) Economic risk of the country would have increased.

Please Discuss in case of Doubt

Best of Luck. God Bless
Please Rate Well