Question

​(Bond valuation​) Bellingham bonds have an annual coupon rate of 11 percent and a par value of $ 1 comma 000 and will mature in 20 years. If you require a return of 12 ​percent, what price would you be willing to pay for the​ bond? What happens if you pay more for the​ bond? What happens if you pay less for the​ bond? a. The price you would be willing to pay for the bond is ​-----?

Answer 1

Calculation of price that we would willing to pay for this bond would be as follows.

Present value of bond = present value of face value of bond + present value of interest payment

= face value / (1+required return)^{number of payment}  + interest [1 - (1+required return)^{-number of payment} ]/ required rate

   = $1000 / (1 + 0.12)²⁰ + ($1000 * 11%) [1 - (1 + 0.12)^-20 ]/ 0.12

= $1000 / (1.12)^₂₀ + $110 [1 - (1.12)^-20 ] / 0.12

=$1000 /9.6462931 + $110 [1 - 1/9.6462931 ] / 0.12

=$1000 /9.6462931 + $110 *0.8963332 / 0.12

=103.67 + 821.64

=$925.30

b.) The bond is not an acceptable investment if you pay more for the bond because the expected rate of return for the bond is less than your required rate of return. Paying more than the present value of bond will not satisfy its required rate of return of bond.

If you pay less for the bond you will be earning higher rate of return than the required rate.in such case bond is acceptable investment