Question

1. What is the value of a 7% coupon bond with these characteristics? Would we now have a discount or premium bond?
2. What would happen to the values of the 7%, 10%, and 13% coupon bonds over time if the required return remained at 10%? (Hint: With a financial calculator, enter PMT, I/YR, FV, and N; then, change (override) N to see what happens to the PV as it approaches maturity.)

Please show how to solve.

Answer 1

Value of Bond when required return is 10%

7% coupon Bond: the coupon rate is lower than required rate. it means the market is expecting 10% return from bonds but this particular bond is paying only 7% which makes the bond to sell at below par value which means This Bond is a  Discount Bond

10% coupon Bond: the coupon rate is equal than required rate. it means the market is expecting 10% return from bonds and this particular bond is paying 10% which makes the bond to sell at par value which means This Bond is par value Bond

13% coupon Bond: the coupon rate is higher than required rate. it means the market is expecting 10% return from bonds and this particular bond is paying 13% which makes the bond to sell at above par value which means This Bond is premium Bond

How to calculate the value of Bond using Financial Calculator:

PMT = Annual Coupon; Annual Coupon = face Value * Coupon rate

I/YR = Required rate of return;

FV = Maturity value;

N = Number of years till maturity

PV = Value of bond today

now calculation is PV(PMT,I/YR,FV,N) will give you value of bond in financial calculator