Question:
Suppose there is a bond in ABC Company that that pays coupons of 8.5%, and suppose that these coupons are paid annually.
Suppose the face value of the ABC bond is $1000 and the maturity is 11 years.
If the appropriate discount rate for this bond is 6%, what would you be willing to pay for ABC’s bond?
Answer:
Price of bond = $ 1197.17
Explanation:
<em>The value of the bond is the present value(PV) of the future cash receipts expected from the bond. The value is equal to present values of interest payment plus the redemption value (RV)</em>.
Value of Bond = PV of interest + PV of RV
The price of the bond can be worked out as follows:
S<em>tep 1 </em>
<em>PV of interest payments </em>
Annual Interest payment = 8.5%× 1000 = 85
Annual yield = 6%
Total period to maturity (in years) = 11
PV of interest =
85 × (1- (1+0.06)^(-11)/)/0.06 = 670.38
<em />
<em>Step 2 </em>
<em>PV of Redemption Value </em>
= 1,000 × (1.06)^(-11) = 526.78
<em>Step 3:</em>
<em>Price of bond </em>
670.38 + 526.78= 1,197.17
Price of bond = $ 1197.17
