Question

For example, assume Oliver wants to earn a return of 12.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a 10.00% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bond's intrinsic value: Intrinsic Value = do.1 +040* + 0,40 + fcy* + others + otcovo + detery Complete the following table by identifying the appropriate corresponding variables used in the equation. Variable Value Unknown Variable Name Bond's semiannual coupon payment Bond's market price $1,000 Semiannual required return to expect that Oliver's potential bond investment is currently exhibiting an intrinsic Based on this equation and the data, it is value less than $1,000. Now, consider the situation in which Oliver wants to earn a return of 13%, but the bond being considered for purchase offers a coupon rate of 10.00%. 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

Answer 1

Bond’s semi annual coupon payment = 1000*10%*1/2

= $50

Bond par value= $1000

Semi annual required return = 12%/2 = 6%

Reasonable to expect, since the required return is higher than coupon rate, the bond will trade at less than par

Intrinsic value is equal to the present value of all future coupon payments and the principal amount

= 1000*10%*1/2*PVAF(6.5%, 6 periods) + 1000*PVF(6.5%, 6 periods)

= 50*4.841 +1000*0.685

= $927.05

i.e. $927

Less than par value

Trading at discount