Question

A. Allied Banks has outstanding a RS 1,000 par-value bond with a 7% coupon interest rate. The bond has 10 years remaining to its maturity date.a. If interest is paid annually, find the value of the bond when the required return is(1) 7%, (2) 5%, and (3) 10%. b. Indicate for each case in part a whether the bond is selling at a discount, at a premium, or at its par value.

Answer 1

Required rate of return is 7%
Year	cash flow	present value of cash flow at 7% =1/(1+r)^n r =7%
1	70	65.42056
2	70	61.14071
3	70	57.14085
4	70	53.40266
5	70	49.90903
6	70	46.64396
7	70	43.59248
8	70	40.74064
9	70	38.07536
10	1070	543.9337
Value of bond = sum of present value of cash flow		1000
As the required rate of return and coupon rate is equal would be sold at par value
Required rate of return is 5%
Year	cash flow	present value of cash flow at 5% =1/(1+r)^n r =5%
1	70	66.66667
2	70	63.49206
3	70	60.46863
4	70	57.58917
5	70	54.84683
6	70	52.23508
7	70	49.74769
8	70	47.37876
9	70	45.12262
10	1070	656.8872
Value of bond = sum of present value of cash flow		1154.435
As the required rate of return is less than the coupon rate so bond would be sold at premium value
Required rate of return is 10%
Year	cash flow	present value of cash flow at 10% =1/(1+r)^n r =10%
1	70	63.63636
2	70	57.85124
3	70	52.59204
4	70	47.81094
5	70	43.46449
6	70	39.51318
7	70	35.92107
8	70	32.65552
9	70	29.68683
10	1070	412.5313
Value of bond = sum of present value of cash flow		815.663
As the required rate of return is more than the coupon rate so bond would be sold at discount value