Question

John Wilson is a conservative investor who has asked your advice about two bonds he is considering. One is a seasoned issue of the Capri Fashion Company that was first sold 22 years ago at a face value of $1000, with a 25-year term, paying 5%. The other is a new 30-year issue of the Gantry Elevator Company that is coming out now at a face value of $1000. Interest rates are now 5%, so both bonds will pay the same coupon rate. Assume bond coupons are paid semiannually.

1. What is each bond worth today? Round the answers to the nearest cent.
   
   Capri Fashion Company bond: $   
   Gantry Elevator Company bond: $   
   
2. If interest rates were to rise to 10% today, estimate without making any calculations what each bond would be worth.
   The input in the box below will not be graded, but may be reviewed and considered by your instructor.
   
   
   
3. If interest rates were to rise to 10% today, find what each bond would be worth to decide which bond is the better investment in this case. Do not round intermediate calculations. Round PVFA and PVF values in intermediate calculations to four decimal places. Round the answers to the nearest cent.
   
   Capri Fashion Company bond: $   
   Gantry Elevator Company bond: $   
   
4. If interest rates are expected to fall, which bond is the better investment?
   Gantry Elevator Company bond
   
   Are long-term rates likely to fall much lower than 6%?
   Unlikely

Answer 1

The value of bond are calculated by use of

$V=\sum_{i=1}^{n}\frac{C_i}{(1+r)^i}+ \frac{Maturity\ value}{(1+r)^n}$

answer a)

	Capri	Gantry
Face value(FV)	1000	10000
Maturity time	3	30
Number of payment(nper)	6	60
Coupon Rate	5%	5%
Semiannual coupon(PMT)	25	25
Interest Rate ( r )	5%	5%	2.5%(semi annual)
Value of bond	$1,000.00	$1,000.00
	PV(2.5%, 6,-25,-1000)	PV(2.5%, 60,-25,-1000)

Answer 2) change is interest rate has higher impact on long maturity bond and value of bond has inverse relation with change in interest rate.

The value of Gantry bond would have higher impact.

Capri bond = $873

Gantry Bond= $ 526

Answer 3)

	Capri	Gantry
Face value(FV)	1000	10000
Maturity time	3	30
Number of payment(nper)	6	60
Coupon Rate	5%	5%
Semiannual coupon(PMT)	25	25
Interest Rate ( r )	10%	10%	5%(semi annual)
Value of bond	$873.1077	$526.7678
	PV(5%, 6,-25,-1000)	PV(5%, 60,-25,-1000)

Answer d) In case of fall of interest , the longer maturity bond act as a defensive strategy for interest rate risk.

So, Gantry Elevator Company bond

Answer e) As per current interest rate scenario in long run , it is unlikely to fall interest rate by 6%.