Question

Consider a $1,000 par value bond with a 9% annual coupon. The bond pays interest annually. There are 20 years remaining until maturity. You have expectations that in 5 years the YTM on a 15-year bond with similar risk will be 7.5%. You plan to purchase the bond now and hold it for 5 years. Your required return on this bond is 10%. How much would you be willing to pay for this bond today?

Select one:

a. $1044

b. $ 962

c. $1132

d. $ 988

e. $1153

Answer 1

	The value of bond is the Present Value of of all the expected future cash flows
	Par Value of bond						$1000
	Annual Coupon rate						9%
	Required rate of return						10%
	Annual interest ( 1000*9%)						$90
	Discounted Factor for 5 years(PVIAF)						3.79078676
	( = 1/1.10^1+1/1.10^2+1/1.10^3+1/1.10^4+1/1.10^5)
	Discounted Factor of year 5th ( PVIF)						0.6209213
	( = 1/1.10 ^5 )
	Value of Bond = $90 * PVIAF ( 10% , 5 year ) + $ 1000 PVIF (10% , 5 year )
		= $90 * 3.79078676 + $1000 * 0.6209213
		= $341.1708 + $620.9213
		= $962
	We willing to pay $962 for this bond today
	Option B - $962