Question

​(Bond valuation​) Kyser Public Utilities issued a bond with a ​$1000 par value that pays ​$80 in annual interest. It matures in 20 years. Your required rate of return is 9 percent.

a. Calculate the value of the bond.

b. How does the value change if your required rate of return​ (1) increases to 12 percent or​ (2) decreases to 6 ​percent?

c. Explain the implications of your answers in part ​(b​) as they relate to interest rate​ risk, premium​ bonds, and discount bonds.

d. Assume that the bond matures in 10 years instead of 20 years. Recompute your answers in part ​(b​).

e. Explain the implications of your answers in part ​(d​) as they relate to interest rate​ risk, premium​ bonds, and discount bonds.

Answer 1

c. There is an inverse relation between the required rate of return and the price of the bond and with increase in the required rate of return, the price of the bond decreases.

If the required rate of return incraeses, the bond generally is sold at a discount and in case of decrease in the required rate of return, the bond is sold at a premium.

e. There is a concept of interest rate risk which is directly proportional to the maturity. Longer maturity would mean greater interest rate risk and vice- versa.