Question

1. Develop a valuation model for a corporate bond with a par value at maturity of $1,000, a maturity of 20 years, a coupon interest rate of 7%, and a yield to maturity of 4%. The coupons are assumed to be paid semi-annually. In your development and presentation, include a time line showing the relevant cash flows along with all of the steps that allow you to generate the value (price of the bond).
2. Given the problem above, identify how the bond price will be expected to adjust across time as the bond approaches maturity. You should calculate the price after each 2-year period has passed – i.e., after year 2, year 4, year 6, year 8, year 10, year 12, year 14, year 16, year 18, and year 20. Graph the resulting movement in the price across time using the resulting values. Explain how this movement in the bond price across time is important for the investor.

Answer 1

FV = 1000, PMT = 35, rate = 2%, N = 40

use PV function in Excel

price = 1410.33

now similarly replace N = 36 for after 2 years and calculate PV

price = 1382.33

now similarly replace N = 32 for after 4 years and calculate PV

price = 1352.03

now similarly replace N = 28 for after 6 years and calculate PV

price = 1319.22

now similarly replace N = 24 for after 8 years and calculate PV

price = 1283.71

now similarly replace N = 20 for after 10 years and calculate PV

price = 1245.27

now similarly replace N = 16 for after 12 years and calculate PV

price = 1203.67

now similarly replace N = 12 for after 14 years and calculate PV

price = 1158.63

now similarly replace N = 8 for after 16 years and calculate PV

price = 1109.88

now similarly replace N = 4 for after 18 years and calculate PV

price = 1057.12

now similarly replace N = 0 for after 20 years and calculate PV

price = 1000

As the time to maturity decreases, the bond price converges to the par value if there is no change in yield to maturity