Question

The process of bond valuation is based on the fundamental concept that the current price of a security can be determined by calculating the present value of the cash flows that the security will generate in the future. There is a consistent and predictable relationship between a bond's coupon rate, its par value, a bondholder's required return, and the bond's resulting intrinsic value. Trading at a discount, trading at a premium, and trading at par refer to particular relationships between a bond's intrinsic value and its par value. These result from the relationship between a bond's coupon rate and a bondholder's required rate of return. pay, and a bondholder's required return Remember, a bond's coupon rate partially determines the interest-based return that a bond reflects the return that a bondholder to receive from a given investment. The mathematics of bond valuation imply a predictable relationship between the bond's coupon rate, the bondholder's required return, the bond's par value, and its intrinsic value. These relationships can be summarized as follows: • When the bond's coupon rate is equal to the bondholder's required return, the bond's intrinsic value will equal its par value, and the bond will trade at par. its par • When the bond's coupon rate is greater to the bondholder's required return, the bond's intrinsic value will value, and the bond will trade at a premium. • When the bond's coupon rate is less than the bondholder's required return, the bond's intrinsic value will be less than its par value, and the bond will trade at For example, assume Oliver wants to earn a return of 9.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a 15.75% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bond's intrinsic value: Intrinsic Value = (1+C+ (1+cm2 + (1 fc3 + (1 fc3* + (fcy8 + (1fCJ8 + (1.co Complete the following table by identifying the appropriate corresponding variables used in the equation. Unknown Variable Name Variable Value $1,000 Semiannual required return to expect that Oliver's potential bond investment is currently exhibiting an intrinsic value Based on this equation and the data, it is greater than $1,000.

Answer 1

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- 2x Cells BY CG 197 BOND - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut Σ AutoSum : A Calibri -11AA = = = Dr Wrap Text General Ea Copy Fill Paste U D- DA E E E BI s FMerce Merge & Center - Center $ % % , 4.0 .00 :.: Conditional Format Cell Insert Delete Format Sort & Find & Format Painter Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Editing CC213 BW BX BZ CA CBCC CD C E CE 195 196 A bonds coupon rate partially determines the interest based return that a bond WILL pay, and a bond holders required return reflects the return that a bondholder WOULD LIKE to receive from a given instrument 198 199 When the bond's coupon rate is greater than the bondholder's required return, the bond's intrinsic value will EXCEED than its par value & the bond will trade at a premium 201 202 When the bond's coupon rate is less than the bondholder's required return, the bond's intrinsic value will less than its par value & 203 the bond will trade at a DISCOUNT 204 205 UNKNOWN VARIABLE NAME VARIABLE VALUE 206 BONDS SEMI ANNUAL COUPON PAYMENT 78.75 207 BONDS PAR VALUE 1000 208 SEMI ANNUAL REQUIRED RETURN 4.5% 200 209 210 FV 1000.00 15.75% SEMI ANNUALLY COUPON 211 212 LIFE 213 214 ► Rea REQUIRED RATE PRICE OF BOND IF COUPON PAID SEMI ANNUALLY = YIELD SPOT Sheet2 AFN BANKING NOTE 51 53 CLEAN PRICE S10 ferences 9% $ 1,174.08 BIDDING, UNDERWRITING EUAC AW LIFE LP, IP, MRP, INFLATION WARRANT refund 0 0 S4 S5 S6 BOJ 120% 0 + 1a e 9 . SPOR 9 * R 40 ENG 07-11-2019

BOND - Microsoft Excel (Product Activation Failed) Add-Ins View - 2x Dr General File Home Insert Page Layout Formulas Data Review % Cut Calibri -11AA = = = Ea Copy Paste BIU - D A Format Painter Clipboard Font Wrap Text Merge & Center - $ . Insert Delete Format % , Number Conditional Format Formatting as Table Styles Cell Styles Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select Alignment Cells BZ231 BW BX BY BZ CA CB CDCECECG E 218 219 220 221 222 223 Now, consider the situation in which Oliver wants to earn a return of 13.75%, but the bond being considered for purchase offers a coupon rate of 15.75%. Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the bond's intrinsic value to the nearest whole dollar, then its intrinsic value of $1048 is MORE THAN its par value, so that the bond is AT PREMIUM [=PV(13.75%/2,3*2,-157.5/2,-1000)] 224 225 Given your computation and conclusions, which of the following statements is true? CORRECT ANSWER: When the coupon rate is greater than Oliver's required return, the bond should trade at a premium. 226 227 228 229 230 231 232 233 234 235 236 237 Sheet2 AFN BANKING NOTE 51 53 CLEAN PRICE 510 BIDDING, UNDERWRITING EUAC AW LIFELP, IP, MRP, INFLATION WARRANT refund Y IELD SPOT 1 ferences 54 55 56 I BOU 120% Rea -_- S E O * 10 ENG 07-11-2019