Question

Bond X is noncallable and has 20 years to maturity, a 7% annual coupon, and a $1,000 par value. Your required return on Bond X is 10%; if you buy it, you plan to hold it for 5 years. You (and the market) have expectations that in 5 years, the yield to maturity on a 15-year bond with similar risk will be 11%. How much should you be willing to pay for Bond X today? (Hint: You will need to know how much the bond will be worth at the end of 5 years.) Do not round intermediate calculations. Round your answer to the nearest cent.

$__________

Answer 1

First calculate the price of bond or value of bond at 5^th year from today:

Using financial calculator BA II Plus - Input details:	#
I/Y = Rate or yield / frequency of coupon in a year =	11.000000
PMT = Payment = Coupon rate x FV / frequency =	-$70.00
N = Total number of periods = Number of years x frequency =	15
FV = Future Value or Face Value =	-$1,000.00
CPT > PV = Value of Bond 5 years from now* =	$712.37

Now, calculate the value of bond for today by keeping FV value as calculated “*Value of bond 5 years from now”:

Using financial calculator BA II Plus - Input details:	#
I/Y = Rate or yield / frequency of coupon in a year =	10.000000
PMT = Payment = Coupon rate x FV / frequency =	-$70.00
N = Total number of periods = Number of years x frequency =	5
FV = Future Value = Value of Bond 5 years from now* =	-$712.37
CPT > PV = Present Value of Bond X today =	$707.68

How much should you be willing to pay for Bond X today?

The value investor should pay today = $707.68