Question
In: Finance
A bond very recently purchased for $9,000 has a face value of $10,000 and a bond...
A bond very recently purchased for $9,000 has a face value of $10,000 and a bond interest rate of 10% per year payable semiannually. The bond is due (matures) in 3 years. The company that issued the bond is contemplating a liquidity problem in 3 years and has just advised all bondholders that if they will keep their bonds for an additional 2 years past the original due date, the bond interest rate for the additional two years will be 16% payable semiannually. (a) What effective rate of return per year would the bondholder receive if he held the bond for the additional two years? (b) What is the market value for the bond if the required market rate of return on such bonds is 10%? Ignore the impacts of taxation.
PLEASE SHOW EVERY STEP IN DETAIL, especially for PART A. I don't understand it!
Solutions
Expert Solution
(a) Calculation of effective rate of return per year that the bondholder receive if he held the bond for the additional two years
[As Interest is payable semiannually, therefore half of the
Interest rate is taken]
= 0.089 or 8.9%
(b) Calculation of market value for the bond if the required market rate of return on such bonds is 10%
[As Interest is payable semiannually, therefore half of
the Interest rate is taken]
Value of Bond at 10% rate of return is $18,402.3
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