In: Finance
Jupiter Aviation Inc. has 2 different bonds outstanding. Bond A has a face value of $35,000 and a maturity of 10 years. It makes no coupon payments over the life of the bond. Bond B also has a face value of $35,000 with 10 years to maturity. It makes no payments for the first 5 years, then pays $1,000 every 6 months over the subsequent 2 years, and finally pays $2,000 every 6 months over the last 3 years. If the required return on both of these bonds is 5% compounded semi-annually, what is the current price of bond A? Of bond B?
Solution) For Bond A:
Face Value (FV) = $35,000
Years to maturity = 10 years
Since, compounding is done on semiannual basis, thus, number of periods (Nper) = 10*2 = 20
Coupon payment (PMT) = 0
Required Return = 5% compounded semi-annually
Rate per period (Rate) = 5%/2 = 2.5%
The current price of the bond can be calculated using the PV function in Excel = PV(Rate, Nper, PMT, FV, Type)
= PV(2.5%, 20, 0, 35000, 0)
= -21,359.48
(Negative sign indicates the cash outflow)
Thus, the current price of the bond A = $21,359.48
For Bond B,
Face Value (FV) = $35,000
Years to maturity = 10 years
Since, compounding is done on semiannual basis, thus, number of periods (Nper) = 10*2 = 20
Required Return = 5% compounded semi-annually
Rate per period (Rate) = 5%/2 = 2.5%
For first 5 years, there is no coupon payments, thus, for first 10 periods there is no coupon payments.
The coupon payments are shown as below:
At maturity of the bond, the investor will receive the coupon as well as the Face Value = 2000 + 35000 = $37,000
The current price of the bond is calculated using the NPV function in Excel = NPV(Rate, cash flows from t=1)
= NPV(2.5%, cash flows from t=1)
The current price of the bond B = $32,094.83
Please comment in case of any doubts or clarification required. Please Thumbs Up!!