Question

A bond with a $1,000 face value and a 10 percent annual coupon rate matures in 15 years. a. Determine the value of the bond to a friend of yours with a required rate of return of 13%. b. A zero coupon bond with similar risk is selling for $180. The bond has a face value of $1,000 and matures in 15 years. Your friend asks you which bond she should invest in

Answer 1

Based on the details given, the following are true:

• a. Value of bond = $806.09
• b. Your friend should invest in the bond with $1,000 face value

Value of Bonds

First find coupon:

= 10% x 1,000

= $100

Bond A

= (Coupon x Present value interest factor of annuity, 13%, 15 years) + Face value of bond / ( 1 + 13%)¹⁵

= ( 100 x 6.462) + (1,000 / 1.13¹⁵)

= $806.09

Bond B

= Face value - Current value

= 1,000 - 180

= $820

In conclusion, Bond B is overvalued so your friend should pick Bond A.

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