Question

Midland Utilities has a bond issue outstanding that will mature to its $1,000 par value in 19 years. The bond has a coupon interest rate of 11​% and pays interest annually.

a. Find the value of the bond if the required return is​ (1) 11​%, ​(2) 15​%, and​ (3) 8​%.

b. Use your finding in part a and the graph​ here, to discuss the relationship between the coupon interest rate on a bond and the required return and the market value of the bond relative to its par value.

c. What two possible reasons could cause the required return to differ from the coupon interest​ rate?

Answer 1

Question 1

Given,

Face value of the bond = $1000

Time to maturity = 19years

Coupon rat of bond = 11%

Computation of value of bond if the required rate of return is 11%

Value of the bond = [Interest amount PvAF(11%,19y)] + [Redemption value PvF(11%,19y)]

= [110 7.839] + [1000 0.14] = $862.29 + $140 = $1002.29.

Computation of value of bond if the required rate of return is 15%

Value of the bond = [Interest amount PvAF(15%,19y)] + [Redemption value PvF(15%,19y)]

= [110 6.198] + [1000 0.0703] = $681.78 + $70.3 = $752.08.

Computation of value of bond if the required rate of return is 8%

Value of the bond = [Interest amount PvAF(8%,19y)] + [Redemption value PvF(8%,19y)]

= [110 9.604] + [1000 0.2317] = $1056.44 + $231.7 = $1288.14

Question 2

On seeing the above calculations, we conclude that required rate of return is inversly proportional to market value of the bond.

If the required rate of return increases then market value of the bond decreases.

and the same way required rate of return decreases then market value of the bond increases.

Coupon rate of the bond is constant through out the life of the bond.hence value of the bond or required rate of return doesnot change with the coupon rate of the bond.

Question 3

Reasons for the required rate of return differ from coupon rate

Time value of the money

Expectationf of investors

.