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A corporate bond has a $1,000 face value and a 5 percent coupon rate (annual payments)...

A corporate bond has a $1,000 face value and a 5 percent coupon rate (annual payments) maturing in 3 years. a. If the yield to maturity is 7%, what is the bond price? 2 marks b. An investor believes an appropriate rate to discount the future cash flow of the bond should be 6%, should the investor buy or sell the bond? Discuss the reason(s).

Expert Solution

a.

Bond's Price

=-pv(rate,nper,pmt,fv)

= $ 947.51

Where,

rate

=

7%

nper

=

3

pmt

=

1000*5%

=

$ 50.00

fv

=

$ 1,000.00

b.

Investor should buy the bond.

(a) At 6% discount rate, price of bond is $ 973.27.It means at 7%, Price of bond is undervalued and it is better to buy the bond.

(b) Existing bond is paying 7% Yield to maturity which is more than 6%. So, this bond is paying more.

Working:

Bond's Price at 6%

=-pv(rate,nper,pmt,fv)

= $ 973.27

Where,

rate

=

6%

nper

=

3

pmt

=

1000*5%

=

$ 50.00

fv

=

$ 1,000.00

jeff jeffy answered 2 years ago

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A corporate bond has a $1,000 face value and a 5 percent coupon rate (annual payments)...

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