Question

(Bond valuation​) You own a 20​-year, $1,000 par value bond paying 8 percent interest annually. The market price of the bond is ​$850 and your required rate of return is 11 percent.

a. Compute the​ bond's expected rate of return.

b. Determine the value of the bond to​ you, given your required rate of return.

c. Should you sell the bond or continue to own​ it?

Answer 1

a. Current price of the bond can be substituted in the equation below to find the expected rate of return:

Using Excel's goal seek function we get the expected rate as 9.7295%

Below is the CF schedule:

b. Using the required rate of 11%, the value of the bond is as follows:

c. Now as the price of the bond when discounted using the required rate is lower than the market price, we are getting a good price for the bond and should sell it at a profit of 850-761 =  $88.90