Question

6.   Murphy Manufacturing has just issued a 15-year, 12% coupon interest rate, $1,000-par bond that pays interest annually. The required return is currently 11%, and the company is certain it will remain at 11% until the bond matures in 15 years.

1. Assuming that the required return does remain at 11% until maturity, find the value of the bond with (1) 15 years, (2) 12 years, (3) 9 years, (4) 6 years, (5) 3 years, and (6) 1 year to maturity.
2. Plot your findings on a set of “time to maturity (x axis) – market value of bond (y axis).
3. All else remaining the same, when the required return differs from the coupon interest rate and is assumed to be constant to maturity, what happens to the bond value as time moves toward maturity? Explain in light of the graph in part b.

Answer 1

Part (a)

Value of the bond = - PV (Rate, Nper, PMT, FV) = - PV(11%, Nper, 12% x 1000, 1000) = - PV (11%, Nper, 120, 1000)

Nper	Value
15	1,072
12	1,065
9	1,055
6	1,042
3	1,024
1	1,009

Part (b)

Part (c)

The bond is pulled to par i.e the bond price converge to the face value or par value as the bond nears its maturity. You can observe the same in the graph. When time to maturity is 15 years, the bond value is at the highest. As it moves to 1 year to maturity, the bond value if $ 1,009 - quite close to the par value of $ 1,000. The bond value is thus pulled to par.