Question

A) Sintokyo Berhad’s seven-year RM1,000 par bonds pay 9 percent interest. Your required rate of return is 7 percent. The current market price for the bond is RM1,100.

i. Determine the expected rate of return

ii. What is the value of the bonds to you given your required rate of return?

iii. Should you purchase the bond at the current market price

Answer 1

i]	Expected rate of return is the YTM.
	YTM using the approximate formula = ((90+(1000-1100)/7)/((1100+1000)/2) = 7.21%
	Using the trial and error approach:
	YTM is that discount rate which equates the
	PV of the expected cash flows from the bond
	with its current price.
	The expected cash flows are the maturity
	value [usually equal to the face value] and
	the periodic coupons in the form of an
	annuity.
	Such a discount rate has to be found out by
	trial and error by trying different discount
	rates till the PV of the cash flows equals the
	price of the bond.
	Discounting with 7%:
	PV = 1000/1.07^7+90*(1.07^7-1)/(0.07*1.07^7) =	$     1,107.79
	Discounting with 8%:
	PV = 1000/1.08^7+90*(1.08^7-1)/(0.08*1.08^7) =	$     1,052.06
	YTM = 7%+1%*(1107.79-1100)/(1107.79-1052.06) =	7.14%
	Therefore, expected return =	7.14%
ii]	Value of the bonds given the required rate of return of
	7% is:
	= 1000/1.07^7+90*(1.07^7-1)/(0.07*1.07^7) =	$     1,107.79
iii]	Yes, the bond can be purchased at the current
	market price as it is lower than the value of the bonds
	at the required rate of return.