Question

Jason Allen just received a cash gift from his grandfather. He plans to invest in a five-year bond issued by Blossom Corp. that pays an annual coupon rate of 5.0 percent. If the current market rate is 8.50 percent, what is the maximum amount Jason should be willing to pay for this bond?

Answer 1

Answer:

$862

Explanation:

We assume the face value of the bond to be $1000

Coupon rate is 5% paid annually

Coupon payment = 5% x $1,000 = $50

Current market rate or Yield to Maturity (YTM) = 8.50%

We need to calculate the current market price of this bond.

Current price = $\frac{FaceValue}{(1 + ytm)^{N} }$ + [ Coupon payment x  $\frac{1 - \frac{1}{(1 + r)^{N} } }{r}$   ]

Where,

Face Value = $1000

Coupon Payment = $50

N = 5

r = 0.085 or 8.50 %

After plugging in the values in the above equation We get the current price as $862

$862 is the maximum amount Jason should be willing to pay for this bond