Question

​(Bond

valuationlong dash—zero

coupon​)

The Latham Corporation is planning on issuing bonds that pay no interest but can be converted into

​$1,000at​ maturity, 7 years from their purchase. To price these bonds competitively with other bonds of equal​ risk, it is determined that they should yield 6 percent, compounded annually. At what price should the Latham Corporation sell these​ bonds?

The price of the Latham Corporation bonds should be$

​(Bond

valuation​)

You are examining three bonds with a par value of

​$1,000

​(you receive

​$1,000

at​ maturity) and are concerned with what would happen to their market value if interest rates​ (or the market discount​ rate) changed. The three bonds are

Bond

Along dash—a

bond with 6 years left to maturity that has an annual coupon interest rate of

11percent, but the interest is paid semiannually.

Blong dash—a

bond with

9 years left to maturity that has an annual coupon interest rate of 11

​percent, but the interest is paid semiannually.

Bond

Clong dash—a

bond with

15

years left to maturity that has an annual coupon interest rate of

11 ​percent, but the interest is paid semiannually.

What would be the value of these bonds if the market discount rate were

a.

11

percent per year compounded​ semiannually?

b.

5

percent per year compounded​ semiannually?

c.

17

percent per year compounded​ semiannually?

d. What observations can you make about these​ results?

Answer 1

Answers are available in the image below.

Value of bonds is derived using PV function. Formula is pasted in adjacent cell for ease of reference.

Observation on results:

Other things being equal - bonds with longer time to maturity are more sensitive to changes in yields than short tenure bonds.

Due to convexity effect, downward movement in yield will have greater impact on price as compared to equivalent upward movement in yield