Question

(Bond valuation) You own a 10-year, $1,000 par value bond paying 8 percent interest annually. The market price of the bond is $900, and your required rate of return is 11 percent. a. Compute the bond's expected rate of return. b. Determine the value of the bond to you, given your required rate of return c. Should you sell the bond or continue to own it? a. What is the expected rate of return of the 10-year, $1,000 par value bond paying 8 percent interest annually if its market price is $900? % (Round to two decimal places.) und Jesti

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

ДА В $1,000.00 8% Bond Par value Annual coupon rate Years to maturity Market price of bond rity 10 $900.00 a. Expected rate of return 9.60% b. 11% Required return Value of Bond $823.32 11 12 c. 13 14 Bond is overpriced in the market thus, Sale the bond. 17

Cell reference -

F24 А в -Nmodo Bond Par value Annual coupon rate Years to maturity Market price of bond 1000 0.08 10 900 a. Expected rate of return =RATE(C4,-C3*C2,C5,-C2,0) Required return Value of Bond 0.11 =PV(C9,C4,-C3*C2,-C2,0) 9 b. 10 11 12 c. 13 Bond is overpriced in the market thus, Sale the bond. 14

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.

Answer 2

SOLUTION :

a.

Coupon amount = 1000 * 0.08 = 80 ($) annually.

Market price, P = 900 ($)

Required rate of return, k = 11% = 0.11

Bond period = 10 years

Let expected rate of return be r (in decimals). At this return rate, PV of all inflows of cash through coupons and final redemption  of the bond is equal to the price of the bond.

This means :

900 = 80((1+r)^10 - 1)/(r(1+r)^10) + 1000/(1 + r)^10

By trial and error,  r = 0.09599  = 9.60 % approx.

Hence, expected return of the bond = 9.60 % (ANSWER).

b.

Required rate of return, k = 0.11

=> (1 + k)  = 1.11

Value of the bond 

= 80(1.11^10 - 1)/(0.11*1.11^10) + 1000/1.11^10

= 823.32  ($).  (ANSWER).

c. 

Return of the bond of 9.60% is less than the required rate of return of 11%. So, it should be sold out. (ANSWER).