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Here are data on ​$1,000 par value bonds issued by​ Microsoft, GE​ Capital, and Morgan Stanley....

Here are data on ​$1,000 par value bonds issued by​ Microsoft, GE​ Capital, and Morgan Stanley. Assume you are thinking about buying these bonds. Answer the following​ questions:

a. Assuming interest is paid​ annually, calculate the values of the bonds if your required rates of return are as​ follows: Microsoft, 5.5 percent; GE​ Capital, 16.5 ​percent; and Morgan​ Stanley, 12​ percent; where:

MICROSOFT

GE CAPITAL

MORGAN STANLEY

Coupon interest rate

      

5.25%

         

7.50%

     

8.00%

Years to maturity

            

26           

             

22         

             

18            

b. The bonds are selling for the following​ amounts: Microsoft  $1,057 GE Capital $547 Morgan Stanley $809

What are the expected rates of return for each​ bond?

c. How would the value of the bonds change if​ (1) your required rate of return increased 2

percentage points or​ (2) decreased 2 percentage​ points?

d. Explain the implications of your answers in part ​(c​) in terms of interest rate​ risk, premium​ bonds, and discount bonds.

e. Should you buy the​ bonds? Explain.

Solutions

Expert Solution

a.

Microsoft:

FV = 1000

R = 0.055

N = 26

PMT = 0.0525*1000 = 52.5

Using excel function, PV = PV(R,N,PMT,FV)

PV(0.055,26,-52.5,-1000) = $965.84

GE Capital:

FV = 1000

R = 0.165

N = 22

PMT = 0.075*1000 = 75

Using excel function, PV = PV(R,N,PMT,FV)

PV(0.165,22,-75,-1000) = $473.49

Morgan Stanley:

FV = 1000

R = 0.12

N = 18

PMT = 0.08*1000 = 80

Using excel function, PV = PV(R,N,PMT,FV)

PV(0.12,18,-80,-1000) = $710.01

b.

Microsoft:

FV = 1000

PV = 1057

N = 26

PMT = 0.0525*1000 = 52.5

Using excel function, R = Rate(N,PMT,PV,FV)

Rate(26,-52.5,1057,-1000) = 0.0486 = 4.86%

GE Capital:

FV = 1000

PV = 547

N = 22

PMT = 0.075*1000 = 75

Using excel function, R = Rate(22,-75,547,-1000) = 0.1437 = 14.37%

Morgan Stanley:

FV = 1000

PV = 809

N = 18

PMT = 0.0*1000 = 80

Using excel function, R = Rate (18,-80,809,-1000) = 0.1039 = 10.39%

c.

formula spreadsheet

d.  

From above, when the interest rate decreases value of the bond increases.

If the coupon rate is lower than the interest rate, bonds trade at discount. Similarly, if the coupon rate is higher than the interest rate, bonds trade at premium.

If the coupon rate is equal to the interest rate, then the bonds trade at par value.

jeff jeffy answered 8 months ago
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