Question

Basic bond valuation   Complex Systems has an outstanding issue of

​$1,000​-par-value bonds with a 11​% coupon interest rate. The issue pays interest annually and has 11 years remaining to its maturity date.

a.  If bonds of similar risk are currently earning a rate of return of 8​%, how much should the Complex Systems bond sell for​ today?  

b.  Describe the two possible reasons why the rate on​ similar-risk bonds is below the coupon interest rate on the Complex Systems bond.

c.  If the required return were at 11​% instead of 8​%, what would the current value of Complex​ Systems' bond​ be? Contrast this finding with your findings in part a and discuss.

Answer 1

a.Information provided:

Par value= future value= $1,000

Time= 11 years

Coupon rate= 11%

Coupon payment= 0.11*1,000= $110

Yield to maturity= 8%

The price of the bond today is computed by calculating the present value of the bond.

Enter the below in a financial calculator to compute the present value:

FV= 1,000

N= 11

PMT= 110

I/Y= 8

Press the CPT key and PV to compute the present value.

The value obtained is 1,214.17.

Therefore, Complex Systems should sell the bond today for $1,214.17.

b. Two reasons why rate of retuen is less than the coupon rate:
1. The risk in the firm might be less. The debt repaying capacity of the firms might be high hence the required rate is lower than coupon rate and it is a premium bond
2. When Bond rating agencies provide higher rating (investment grade) then yield will be lower suggesting lower risk .

c.If the required rate is 11% instead of 8%, the bond will sell at par. This is because the bond is not sold at a discount or at a premium.