Question

Bond Valuation and Changes in Maturity and Required Returns Suppose Hillard Manufacturing sold an issue of bonds with a 10-year maturity, a $1,000 par value, a 10% coupon rate, and semiannual interest payments. a. Two years after the bonds were issued, the going rate of interest on bonds such as these fell to 8%. At what price would the bonds sell? Round your answer to the nearest cent. b. Suppose that 2 years after the initial offering, the going interest rate had risen to 13%. At what price would the bonds sell? Round your answer to the nearest cent. C. Suppose that 2 years after the issue date (as in Part a) interest rates fell to 8%. Suppose further that the interest rate remained at 8% for the next 8 years. What would happen to the price of the bonds over time? I. The price of the bond will decline, approaching $1,000 at the maturity date. II. The price of the bond will remain the same. III. The price of the bond will rise, approaching $1,000 at the maturity date. -Select- A.

Answer 1

Given for Hillard Manufacturing's bond at the time of issue,

Face Value = $1000

Coupon = 10% paid semiannually, So coupon = 5% of 1000 = $50

time to maturity 10 years,

a). 2 years after the issue of bond,

time to maturity = 8 years

So total semiannual period remaining = 16

YTM = 8

Using financial calculator to price this bond,

N = 16

PMT = 50

FV = 1000

I/Y = YTM/2 = 4

compute for PV, we get PV = $1116.52

So bond will sell at $1116.52

b). 2 years after the issue of bond,

time to maturity = 8 years

So total semiannual period remaining = 16

YTM = 13%

Using financial calculator to price this bond,

N = 16

PMT = 50

FV = 1000

I/Y = YTM/2 = 6.5

compute for PV, we get PV = $853.48

So bond will sell at $853.48

c). 2 year after issue, interest rate = 8%

So price of bond as calculated in part a = $1116.52

price at maturity of a bond is equal to it Face value, i.e. $1000 in this case. So price will decline over the period and approach $1000 at maturity.

So, option A is correct.