Question

The £40 par value bond with maturity in two years and £5 semi-annual coupon is trading for £50. If the Yield to maturity is 7%, the bond is:

A) Over-valued

B) Fairly-valued

C) Under-valued

D) Over-valued or undervalued applies only to stocks priced through CAPM.

E) Insufficient Information

Answer 1

Price of Bond is nothing but PV of Cash flows from it.

Maturity 2 Year

No. of periods = 2 years * 2 = 4 periods ( semi annual coupon)

YTM = 7 % / 2 = 3.5 % per period

Year	Cash Flow	PVF @3.5 %	Disc CF
1	£         5.00	£ 0.9662	£         4.83
2	£         5.00	£ 0.9335	£         4.67
3	£         5.00	£ 0.9019	£         4.51
4	£         5.00	£ 0.8714	£         4.36
4	£       40.00	£ 0.8714	£       34.86
	Price of Bond	£       53.22

Market price = £ 50

PV of Price of Bond = £ 53.22

PV of price of Bond > Actual MP of Bond

Bond is under valued , buy the bond

Option C is correct answer