Question

Basic bond valuation Complex Systems has an outstanding issue of $1,000-par-value bonds with a16​% coupon interest rate. The issue pays interest annuallyand has 16years remaining to its maturity date.

a. If bonds of similar risk are currently earning a rate of return of 13​%,

how much should the Complex Systems bond sell for​ today?  

b. Describe the two possible reasons why the rate on​ similar-risk bonds is below the coupon interest rate on the Complex Systems bond.

c. If the required return were at 16​% instead of 13​%, what would the current value of Complex​ Systems' bond​ be? Contrast this finding with your findings in partaand discuss.

Answer 1

Coupon =16%*1000 =160
Number of Years =16
a. At rate of return =13%
Price of Bond =PV of Coupons+PV of Par Value =160*((1-(1+13%)^-16)/13%)+1000/(1+13%)^6 =1536.94

b. Two possible reasons why return is less than coupon rate
1. The risk in the firm might be less. The debt repaying capacity of the firms might be high hence the required rate is lower than coupon rate and it is a premium bond
2. When Bond rating agencies provide higher rating (investment grade) then ytm will be lower suggesting lower risk .


c. If Required rate is 16% then required rate and coupon rate are same the Price is same as Par Value.Hence Price =1000
IN part a YTM was less than coupon rate hence it was sold at premium. hence price of bond is higher as compared to price when YTM is higher. Higher the YTM lower the price of bond