A bond with a $1,000 face value and a 15 percent annual coupon rate matures in 30 years.
a. Determine the value of the bond to a friend of yours with a required rate of return of 11%.
b. A zero coupon bond with similar risk is selling for $550. The bond has a face value of $1,000 and matures in 30 years. Your friend asks you which bond she should invest in, the zero coupon bond or the bond in part (a). Which bond do you recommend, and why? Assume the market price of the bond in part (a) is $1020.
(a) Calculation of value of bond
(b) Calculation of value of zero coupon bond
It is recommended to buy bond A (normal coupon bond) because it is selling cheaper in the market for $1,020 as compared to its fair value price of $1,347.75, whereas for zero coupoun bond it is vice-versa.
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