One year ago Lerner and Luckmann Co. issued 15-year, noncallable, 5% annual coupon bonds at their par value of $1,000. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 14 years to maturity?
Select the correct answer.
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Current Price is the sum of the Present Values of |
1. all future coupons on the bond ,till maturity |
2. Face value to be received at maturity |
both discounted at the market interest rate which is the yield on the bond |
based on which the investor will fix the price(as above) |
So, |
Current price/PV=(Pmt.*(1-(1+r)^-n)/r)+(FV/(1+r)^n) |
where , |
Pmt.=Annual coupon payment,ie. 1000*5%=50 ; |
r=Market interest rate or Yield or Yield to maturity, ie. 5.5% or 0.055 |
n= No.of coupon -periods still pending to maturity, ie. 14 |
FV= Face Value,ie. 1000 |
Substituting the numerical values in the above formula, |
Current price/PV=(50*(1-(1+0.055)^-14)/0.055)+(1000/(1+0.055)^14)= |
952.05 |
So, |
ANSWER: b. $ 952.05 |
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