Question

You own a 15-year, $1,000 par value bond paying 6.5 percent interest annually. The market price of the bond is $775 and your required rate of return is 11 percent.

a. Compute the​ bond's expected rate of return.

b. Determine the value of the bond to​ you, given your required rate of return.

c. Should you sell the bond or continue to own​ it?

a. What is the expected rate of return of the 15​-year, $1,000 par value bond paying 6.5 percent interest annually if its market price is $775?___% ​(Round to two decimal​ places.)

b. What is the value of the bond to​ you, given your 11 percent required rate of​ return? $____(Round to the nearest​ cent.)

c. Should you sell the bond or continue to own​ it?  ​

A. You should sell the bond because the​ bond's yield to maturity is higher than your expected rate of return and thus it is undervalued.

B. You should continue to hold the bond because the​ bond's yield to maturity is higher than your expected rate of return and thus it is undervalued.

C. You should sell the bond because the​ bond's yield to maturity is lower than your expected rate of return and thus it is overvalued.

D. You should continue to hold the bond because the​ bond's yield to maturity is lower than your expected rate of return and thus it is overvalued.

Answer 1

Answer a.

Face Value = $1,000
Current Price = $775

Annual Coupon Rate = 6.50%
Annual Coupon = 6.50% * $1,000
Annual Coupon = $65

Time to Maturity = 15 years

Let Annual YTM be i%

$775 = $65 * PVIFA(i%, 15) + $1,000 * PVIF(i%, 15)

Using financial calculator:
N = 15
PV = -775
PMT = 65
FV = 1000

I = 9.35%

Annual YTM = 9.35%

Answer b.

Face Value = $1,000
Annual Coupon = $65
Time to Maturity = 15 years
Annual Rate of Return = 11%

Value of Bond = $65 * PVIFA(11%, 15) + $1,000 * PVIF(11%, 15)
Value of Bond = $65 * (1 - (1/1.11)^15) / 0.11 + $1,000 / 1.11^15
Value of Bond = $676.41

Answer c.

You should sell the bond because the​ bond's yield to maturity is lower than your expected rate of return and thus it is overvalued.