Question

PLEASE SHOW WORK:

Assets, Inc. plans to issue $5 million of bonds with a coupon rate of 7 percent, a par value of $1,000, semiannual coupons, and 30 years to maturity. The current market interest rate on these bonds is 6 percent. In one year, the interest rate on the bonds will be either 9 percent or 5 percent with equal probability. Assume investments are risk-neutral.

a.) If the bonds are noncallable, what is the price of the bonds today?

b.) If the bonds are callable one year from today at $1,080, will their price be greater or less than the price you computed in (a)? Why?

Answer 1

	a)	Price of bond if non -callable
		Number of bond issued =5million/1000	5000
		Face Value of each bond	$1,000
		Expected interest rate after one year=0.5*(9+5)	7%
	Rate	Expected semi annual interest =7/2	3.50%
	Nper	Number of semi annual periods after 1 year	58	(29*2)
	Pmt	Amount of semi annual coupon payment=1000*(7/2)%	$35.00
	Fv	Payment at maturity	1000.00
	PV	Expected Bond Price after one year	$1,000.00
		(Using PV function of excel)
	Rate	Current Semi annual Market Interest=6/2=	3%
	Nper	Number of Coupon payment in one year	2
	Pmt	Amount of semi annual coupon payment=1000*(7/2)%	$35.00
	Fv	Bond Price after one year	$1,000.00
	PV	Current Bond Price =	$1,009.57
		(Using PV function of excel)
	b)	Price of bond if callable
	Rate	Current Semi annual Market Interest=6/2=	3%
	Nper	Number of Coupon payment in one year	2
	Pmt	Amount of semi annual coupon payment=1000*(7/2)%	$35.00
	Fv	Bond Call Price after one year	$1,080.00
	PV	Current Bond Price =	$1,084.98
		(Using PV function of excel)
		Their price will be greater than the price computed in (a)
		Because the Call amount is higher than the expected price of bond after one year
						F15 - X B Fax C =PV(F11, F12,-F13,-1000) D 2 A F G Nm two como Rate Nper Pmt Price of bond if non-callable Number of bond issued =5million/1000 Face Value of each bond Expected interest rate after one year=0.5*(9+5) Expected semi annual interest =7/2 Number of semi annual periods after 1 year Amount of semi annual coupon payment=1000*(7/2)% Payment at maturity Expected Bond Price after one year (Using PV function of excel) 5000 $1,000 7% 3.50% 58 (29*2) 35.00 1000.00 $1,000.00 Fv PV Ile TIME THISCIL Page LayouLTUUlas DalaNEVIEW VIEW TICIP Tell Me Will you wa IL LU UU F21 x B for C A G 17 18 =PV(F17,F18,-F19,-F20) D Rate Current Semi annual Market Interest=6/2= Nper Number of Coupon payment in one year Pmt Amount of semi annual coupon payment=1000*(7/2)% Bond Price after one year PV Current Bond Price = (Using PV function of excel) F 3% 2 $35.00 $1,000.00 $1,009.57 FV 529 : * B v fac C =PV(F25,526,-F27-F28) D A F 13 Pmt 14 FV $35.00 1000.00 $1,000.00 PV 3% Rate Nper Pmt Amount of semi annual coupon payment=1000*(7/2)% Payment at maturity Expected Bond Price after one year (Using PV function of excel) Current Semi annual Market Interest=6/2= Number of Coupon payment in one year Amount of semi annual coupon payment=1000*(7/2)% Bond Price after one year Current Bond Price = (Using PV function of excel) FV $35.00 $1,000.00 $1,009.57 PV 3% b) Rate Nper Pmt Fv PV Price of bond if callable Current Semi annual Market Interest=6/2= Number of Coupon payment in one year Amount of semi annual coupon payment=1000*(7/2)% Bond Call Price after one year Current Bond Price = (Using PV function of excel) $35.00 $1,080.00 $1,084.98