Question

# 2 Jim Busby calls his broker to inquire about purchasing a bond of Disk Storage Systems. His broker quotes a price of $1,200. Jim is concerned that the bond might be overpriced based on the facts involved. The $1,000 par value bond pays 11 percent interest, and it has 20 years remaining until maturity. The current yield to maturity on similar bonds is 9 percent.

a. Calculate the present value of the bond. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)

b. Do you think the bond is overpriced? Yes No

Answer 1

1) Bond valuation is the determination of the fair price of a bond. As with any security or capital investment, the expected value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the value of a bond is obtained by discounting the bond's expected cash flows to the present using an appropriate discount rate.

We find the value of bond using financial calculator:

Feed

N = 20

I/Y = 9

PMT = 1000 * 11% = 110

FV = 1000

Compute PV we get, 1182.57

2) Since the bond is priced at 1200, it is overpriced,