Question

Answer the following questions:

1. What should the current market price be for a bond with a $1,000 face value, a 10% coupon rate paid annually, a required rate of return of 12%, and 20 years until maturity?
2. What should the current market price be for a bond with a $1,000 face value, a 10% coupon rate paid annually, a required rate of return of 8%, and 20 years until maturity?
3. What generalizations about bond prices can you make given your answers to #1 and #2?
4. A bond has a market price of $1,000, a $1,000 face value, a 10% coupon rate paid annually, a required rate of return of 10%, and 30 years until maturity. If the required rate of return immediately increased to 13%, what is the new market price of the bond?
5. A bond has a market price of $1,000, a $1,000 face value, a 10% coupon rate paid annually, a required rate of return of 10%, and 10 years until maturity. If the required rate of return immediately increased to 13%, what is the new market price of the bond?
6. What generalizations about bond prices can you make given your answers to #4 and #5?
7. The CFO of Brady Corp. announces that the firm plans to grow its annual dividend at a rate of 3% forever. The company just paid its annual dividend (Do) of $2.00 per share. If the required rate of return on Brady’s stock is 10%, what should the current price of the stock be?

Answer 1

1. Market Price = 100 * PVAF(12%,20y) + 1,000 * PVF(12%,20y)

Market Price = 100 * 7.469 + 1,000 * 0.10367 = 850.61

2. Market Price = 100 * PVAF(8%,20y) + 1,000 * PVF(8%,20y)

Market Price = 100 * 9.818 + 1,000 * 0.21455 = 1,196.36

3. Generation: When required rate of return of the bond is more than coupon rate, the market price of the bond is less than its par value and when the required rate of return of the bond is less than coupon rate, the market price of the bond is more than its par value