Question

Instructions: You are required to use a financial calculator or spreadsheet (Excel) to solve the problems (provided on page 4) related to risk and return characteristics and stock/bond valuation. You are required to show the following three steps for each problem (sample problems and solutions are provided for guidance):

(i) Describe and interpret the assumptions related to the problem.

(ii) Apply the appropriate mathematical model to solve the problem.

(iii) Calculate the correct solution to the problem.

A firm has a bond issue maturing in seven years with par value of $1,000. Those bonds make annual coupon payments of $70. The market interest rate on similar bonds is 8.50%. What is the bond’s price (round your answer to two decimal places)?

Answer 1

Assumption related to problem - coupon payment will remain constant over the life of bond

bonds would be redeemed at par value

market interest rate will remain the same through the life of bond

2- Value of bond will be calculated by discounting the future cash flow with a discount rate equal to market interest rate and then sum the discounted value of cash flow to find the value of bond.

value of bond

Using present value function in MS excel

pv(rate,nper,pmt,fv,type)

rate = 8.5% nper = 7 pmt = 70 fv =1000 type =0

PV(8.5%,7,70,1000,0)

($923.22)