Question

Bond X is noncallable and has 20 years to maturity, a 8% annual coupon, and a $1,000 par value. Your required return on Bond X is 12%; if you buy it, you plan to hold it for 5 years. You (and the market) have expectations that in 5 years, the yield to maturity on a 15-year bond with similar risk will be 10.5%. How much should you be willing to pay for Bond X today? (Hint: You will need to know how much the bond will be worth at the end of 5 years.) Do not round intermediate calculations. Round your answer to the nearest cent.

Answer #1

Par value of Bond = 1000

Number of Years of maturity = 15

YTM is 10.5%

Coupon =8%*1000 = 80

We need to find price of this 15 year bond = PV of Coupons + PV of
Par Value =80*(1-(1+10.5%)^{-15} )/10.5% +
1000/(1+10.5%)^{15} = 815.15

Sales value of Bond after 5 years of purchase = 815.15

YTM = 12%

Current price of Bond X = PV of coupons + PV of Market value of
bond after 5 years = 80*(1-(1+12%)^{-5} )/12% +
815.15/(1+12%)^{5} = 750.92

Please Discuss in case of Doubt

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