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In: Finance

1. Ron is considering investing in a bond issued by the City of San Diego. The...

1. Ron is considering investing in a bond issued by the City of San Diego. The bond pays semiannual coupons, has a face value of $1,000, has a coupon rate of 8% and matures in 4 years. If the bond has an effective annual yield to maturity of 5.0625%, what fair price should Ron expect to pay for the bond?

Solutions

Expert Solution

Step-1:Calculation of nominal interest rate
Effective annual rate = ((1+(i/n))^n)-1 Where,
      0.050625 = ((1+(i/2))^2)-1 i Nominal annual rate = ?
      1.050625 = (1+(i/2))^2 n Number of time compounds in a year = 2
      1.050625 ^ (1/2) = 1+(i/2)
      1.025000 = 1+(i/2)
      0.025000 = i/2
      0.050000 = i
So, nominal annual interest rate = 5.00%
Step-2:Calculation of fair price of bond
Fair price of bond is the present value of cash flow from bond which is calculated as follows:
Price of bond = =-pv(rate,nper,pmt,fv )
= $ 1,107.55
Where,
pv = Present value of cash flow = ?
rate = Semi annual interest rate = 2.50%
nper = Semi annual periods = 8
pmt = Semi annual coupon payment = $             40
fv = Face value = $       1,000

jeff jeffy answered 3 months ago
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