Question

1. The Back Street Girls Corporation has two different bonds currently outstanding. Bond M has a face value of GH¢20,000 and matures in 20 years. The bond makes no payments for the first six years, then pays GH¢1,000 every six months over the subsequent eight years, and finally pays GH¢1,750 every six months over the last six years. Bond N also has a face value of GH¢20,000 and a maturity of 20 years; it makes no coupon payments over the life of the bond. If the required return on both these bonds is 14 percent compounded semiannually, what is the current price of Bond M? Of Bond N?

Answer 1

Given, Face value of both bonds = 20,000. Maturity= 20 years

Required rate of return= 14% compounded semi annually.

Therefore, rate per period= 7%.

It is assumed that in both the cases,

(i ) the redemption will be in face value in addition to the payment stream stated and

(ii) all payments are at the end the respective period

Current price of the bond is the Present Value of Cash Flows

Bond M:

Given, Cash flows are as follows:

(a ): 1,000 at the end of HY 13 through 28 (16 HYs)

(b ): 1,750 at the end of HY 29 through 40 (12 HYs)

(c ): 20,000 at the end of year 20 (40 HY)

Price= 1,000*(PVA7%,16)*PVIF(7%,12) + 1,750*(PVA7%,12)*PVIF(7%,28) + 20,000*PVIF(7%,40)

=1000*9.446649*0.444012 + 1750*7.942686*0.150402 + 20000*0.066780

=$4,194.42 + $2,090.55 + 1,335.61 = 7,620.58

Bond M:

Coupon payments= Nil

Price= PV of face value after 20 years (40 HYs)

Price=20,000*(7%,40)= 20,000*0.066780 = 1,335.61