Question

Bond valuation​ relationships)

The 17​-year, ​$1000 par value bonds of Waco Industries pay 11 percent interest annually. The market price of the bond is ​$1,095​, and the​ market's required yield to maturity on a​ comparable-risk bond is 8 percent.

a.  Compute the​ bond's yield to maturity.

b.  Determine the value of the bond to you given the​ market's required yield to maturity on a​ comparable-risk bond.

c.  Should you purchase the​ bond?

a.  What is your yield to maturity on the Waco bonds given the current market price of the​ bonds? ​% ​ (Round to two decimal​ places.)

b. What should be the value of the Waco bonds given the market's required yield to maturity on a comparable ­risk bond? (Round to the nearest cent)

c. You Should or should not purchase the Waco bonds at the current market price because they are currently overpriced or underpriced? .

Answer 1

(a) Tenure = 17 years, Par Value = $ 1000, Annual Coupon Rate = 11 %, Market Price = $ 1095

Annual Coupon = 0.11 x 1000 = $ 110

Let the bond's yield to maturity be R %

Therefore, 1095 = Sum of Present Values of the Annual Coupons + Present Value of Redeemed Par Value at Maturity = 110 x (1/R) x [1-{1/(1+R)^(17)}] + 1000 / (1+R)^(17)

Using EXCEL's Goal Seek Function/hit and trial method/a financial calculator to solve the above equation, we get:

R = 0.098282 or 9.8282 %

(b) Required YTM = 8 %

Therefore, Bond Price as per Required YTM = P1 = 110 x (1/0.08) x [1-{1/(1.08)^(17)}] + 1000 / (1.08)^(17) = $ 1273.649

(c) As the actual market price of $ 1095 is lower than the required YTM bond price of $ 1273.649, the bond is underpriced and hence constitutes a good investment.Another way of looking at it is by recognizing that the required YTM is lower than the actual YTM, thereby making the bond investment a wise one.