Question

A 9.5% coupon rate bond (that pays interest every six months), with 4 years until maturity is selling at $950. An investor with a 10 required rate of return ask your advice. What is your advice regarding the purchase of the bond?

Seleccione una:

A.purchase the bond because the bond is undervalued by $33.84

B.not enough data to answer

C.don't purchase because the bond is overvalued

D.don't purchase the bond because the bond is overvalued by $34.15

E.purchase the bond because the bond is undervalued by $34.15

Answer 1

Answer is A.purchase the bond because the bond is undervalued by $33.84.

We can use financial calculator for calculation of price of bond using 10% required rate of return with below keystrokes.

interest is paid semiannually. so maturity, interest and required rate of return will be semi-annual.

N = semi-annual maturity = 4*2 = 8; I/Y = semi-annual required rate of return = 10%/2 = 5%; PMT = semi-annual interest = $1,000*9.5%/2 = $47.5; FV = face value of bond = $1,000 > CPT = compute > PV = price of the bond = $983.84

Calculator will display PV as negative value because it's a cash outflow.

price of the bond at 10% required rate of return should be $983.84 but it is $950. so bond is undervalued by $983.84 - $950 = $33.84.