You buy a $2,000 bond on August 15, 2014, paying bond interest at j2 = 6%...

You buy a $2,000 bond on August 15, 2014, paying bond interest at j₂ = 6% and redeemable at par on August 15, 2024.

a) How much did you pay for the bond if your desired yield rate is j₂ = 7%?

b) After exactly 5 years you sell the bond. Interest rates have dropped and the bond is sold to a buyer to yield at j₁ = 4%. Determine the sale price.

c) Determine the approximate value of the yield rate j₂ to the maturity using the method of average if the bond is quoted at 109.50 on August 15, 2019.

Solutions

Expert Solution

1. The price to be paid for the Bond is the future value of expected cash flows discounted at rate of interest hence periodic cash flows $ 6 per year, expected rate of interest =7%, terminal cash flows $ 100+$6=106$. (Refer table below -)

Hence for $ 2,000 Bond (i.e 20 Bonds investor shall pay 92.98$*20) = $ 1859.53

2. After exactly 5 years, Aug 15, 2019 the bond is sold when expected rate is 4% then the price received on sale would be the PV of Bond future cash flows discounted at 4% for 5 years -

3. In case the Bond is quoted at $ 109.5 on August 15, 2019 then the rate of interest would be such a rate at which PV of Inflows=PV of Outflows hence j2=3.87% using IRR formula, alternatively IRR can be calculated using trial & error method also considering 2 discount rates

Using Trial & Error method-

jeff jeffy answered 1 week ago

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