Question

For example, assume Ethan wants to earn a return of 8.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a 14.00% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bond’s intrinsic value:

Intrinsic ValueIntrinsic Value

=  =

A(1+C)1+A(1+C)2+A(1+C)3+A(1+C)4+A(1+C)5+A(1+C)6+B(1+C)6A1+C1+A1+C2+A1+C3+A1+C4+A1+C5+A1+C6+B1+C6

Complete the following table by identifying the appropriate corresponding variables used in the equation.

Unknown	Variable Name	Variable Value
A
B		$1,000
C	Semiannual required return

Based on this equation and the data, it is   to expect that Ethan’s potential bond investment is currently exhibiting an intrinsic value greater than $1,000.

Now, consider the situation in which Ethan wants to earn a return of 12.00%, but the bond being considered for purchase offers a coupon rate of 14.00%. 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    (rounded to the nearest whole dollar) is   its par value, so that the bond is   .

Given your computation and conclusions, which of the following statements is true?

When the coupon rate is greater than Ethan’s required return, the bond should trade at a premium.

When the coupon rate is greater than Ethan’s required return, the bond’s intrinsic value will be less than its par value.

When the coupon rate is greater than Ethan’s required return, the bond should trade at a discount.

A bond should trade at a par when the coupon rate is greater than Ethan’s required return.

Answer 1

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01:59 w © vora dx 2 ENG , 30-03-2020 ... X C42 X A B C E H A 42 43 44 45 17 52 UNKNOWN 53 VARIABLE NAME BONDS SEMI ANNUAL COUPON PAYMENT BONDS PAR VALUE SEMI ANNUAL REQUIRED RETURN VARIABLE VALUE 70 1000 4.0% 54 55 56 57 FV 1000.00 14.00% PAYABLE SEMI ANNUALLY COUPON LIFE REQUIRED RATE PRICE OF BOND IF COUPON PAID SEMI ANNUALLY = 8% $ 1,157.26 [=PV(D60/2,059*2,-E53,-E54)] 63 Based on this equation and the data, it is REASONABLE to expect that ETHAN's potential bond investment is currently exhibiting an intrinsic value GREATER THAN $1,000. 64 65 ... | ASSETL UTILITY LOAN EAIR OLIVER DAUTEN reinvest Sheet6 Sheet7 Sheet8 Sheet11 Sheet12 Sheet1 ... ©

© vora dx 2 ENG , - w 02:00 30-03-2020 ... X 088 X fc A B C 65 66 Now, consider the situation in which ETHAN wants to earn a return of 12%, but the bond being considered for purchase offers a coupon rate of 14%. 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 $1049 is GREATER THAN its par value, so that the bond is AT PREMIUM 70 71 FV 1000.00 14.00% PAYABLE SEMI ANNUALLY 72 COUPON 73 LIFE 74 REQUIRED RATE 12% 75 PRICE OF BOND IF COUPON PAID SEMI ANNUALLY = $ 1,049.17 (=PV(D74/2,073*2,-E53,-E54)] 76 77 Given your computation and conclusions, which of the following statements is true? CORRECT ANSWER: When the coupon rate is greater than Ethan's required return, the bond should trade at a premium. 78 79 83 84 85 86 87 88 ... ASSETL UTILITY LOAN EAIR OLIVER DAUTEN reinvest Sheet6 Sheet7 Sheet8 Sheet11 Sheet12 Sheet1 ... + 1