Question

What would be the value of the bond described in Part d if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13% return? Would we now have a discount or a premium bond?

Answer 1

Answer:

The value of bond is $837.213, the bond is a discount bond

Explanation:

Solution

Given that

The Rate of return is 13% which is higher than the  coupon rate.

What this suggest is that the investors anticipates a return that is higher when compared to return supplied by bonds. thus, the bond value we decrease and it becomes a discount bond.

Now,

The bond value is given below:

Bond value = [Coupon rate in year 1 / ( 1 + Investor return )1 + Coupon rate in year 2 / ( 1 + Investor return )2 + Coupon rate in year n / ( 1 + Investor return )n ] +  Par value / ( 1 + investor return )n

Thus,

= [ $100 / (1 + 0.13)1 + $100 / ( 1 + 0.13)2... $100 / ( 1 + 0.13)10 ] + $1000 / ( 1 + 0.13 )10

= $542.62 + 294.58

= $837.21

Value of bond will be = $837.213