Question

In: Economics

You have a chance to buy a BB-rated Grandview, Inc. bond that has a face value...

You have a chance to buy a BB-rated Grandview, Inc. bond that has a face value of $1,000. The bond has a 7% coupon rate of interest and matures in six years. Interest is paid semi-annually. BB-rated bonds of similar maturity pay an interest rate of 8%. How much should you be willing to pay for the Grandview bond?

Solutions

Expert Solution

The value of a bond today is the sum of the present value of the interest payments (valued as an ordinary annuity) and the present value ( semi annualy) of the face value (discounted as a lump-sum):

  • Present Value Paid at Maturity = Face Value / (Market Rate/ 100) ^ Number Payments
  • Present Value of Interest Payments = Payment Value * (1 - (Market Rate / 100) ^ -Number Payments) / Number Payments)
  • Present Value of Bond = Present Value Paid at Maturity + Present Value of Interest Payments

Here, Face Value = $ 1000

Coupon Rate = 7%

Market Interest Rate = 8%

Maturity Period = 6 yrs

Thus putting all the values in the above mentioned formula we get

Answer : Bond Value = $ 953.07

Note : A BB rating reflects an opinion that that the issuer has the current capacity to meet its debt obligations but faces more solvency risk than an A-rated issue and less than a BBB-rated issue if business, financial, or economic conditions change measurably.

Rahul Sunny answered 2 years ago
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