Question

(Bond

valuation​)

You own a

20​-year,

​$1,000

par value bond paying

7.5%

percent interest annually. The market price of the bond is

​$775

and your required rate of return is

12

percent.

a. Compute the​ bond's expected rate of return.

b. Determine the value of the bond to​ you, given your required rate of return.

c. Should you sell the bond or continue to own​ it?

Answer 1

(a)-Bond’s Expected Rate of Return

Bond’s Expected Rate of Return = [{Annual Coupon Amount + (Current Market Price – Face Value of the Bond)} / Face Value of the Bond ] x 100

= [{$75 + ($775 - $1,000)} / $1,000] x 100

= [($75 - $225) / $1,000] x 100

= [-$150 / $1,000] x 100

= -15.00% (Negative Expected Rate of Return)

“The Bond’s Expected Rate of Return = -15.00%”

(b)-Value of the Bond at required rate of return of 12%

The Value of the Bond is the Present Value of the Coupon payments plus the Present Value of Par Value

Par Value = $1,000

Annual Coupon Amount = $75 [$1,000 x 7.50%]

Yield to Maturity (YTM) = 12%

Maturity Years = 20 Years

The Value of the Bond = Present Value of the Coupon payments + Present Value of Par Value

= $75[PVIFA 12%, 20 Years] + $1,000[PVIF 12%, 20 Years]

= [$75 x 7.46944] + [$1,000 x 0.10367]

= $560.21 + $103.67

= $663.88

“The Value of the Bond = $663.88”

(c)-Sell/Own Decision

“WE SHOULD SELL THE BOND”. If the Present Value of the Bond is less than the Par Value of the Bond, then we should sell the bond and else continue to own.