Question

omplete the following table by identifying the appropriate corresponding variables used in the equation. Variable Value $70.00 $1,000 7.1250% Unknown Variable Name Bond's semiannual coupon payment Semiannual required return Based on this equation and the data, it is reasonable greater than $1,000. to expect that Sophia's potential bond investment is currenty exhibiting an intrinsic value Now, consider the situation in which Sophia wants to earn a return of 17%, 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 bond is (rounded to the nearest whole dollar) is its par value, so that the Given your computation and conclusions, which of the following statements is true? O When the coupon rate is greater than Sophia's required return, the bond should trade at a premium O When the coupon rate is greater than Sophia's required return, the bond should trade at a discount. O When the coupon rate is greater than Sophia's required return, the bond's intrinsic value will be less than its par value O A bond should trade at a par when the coupon rate is greater than Sophia's required return.

Answer 1

Answer a.

Unknown Variable A:

Annual Coupon Rate = 14.00%
Semiannual Coupon Rate = 7.00%

Bond’s Semiannual Coupon Payment = 7.00% * $1,000
Bond’s Semiannual Coupon Payment = $70.00

Unknown Variable B:

Bond’s Par Value = $1,000

Unknown Variable C:

Annual Required Return = 14.25%

Semiannual Required Return = 7.125%

Answer b.

Based on this equation and the data, it is unreasonable to expect that Sophia’s potential bond investment will exhibit an intrinsic value greater than $1,000.

Answer c.

Annual Required Return = 17.00%
Semiannual Required Return = 8.50%

Time to Maturity = 3 years
Semiannual Period to Maturity = 6

Price of Bond = $70.00/1.085 + $70.00/1.085^2 + $70.00/1.085^3 + $70.00/1.085^4 + $70.00/1.085^5 + $70.00/1.085^6 + $1,000/1.085^6
Price of Bond = $932

Now, consider the situation in which Sophia wants to earn a return of 17.00%, 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 $932 is less than its par value, so that the bond is trading at a discount.

Answer d.

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