Question

A $5 million bond was issued at face value on June 1, 2017. The bond has a twenty five year term and a fixed interest rate of 4% paid annually. At the time of issuance, the current market rate of interest is also 4%. Using the present value tables, demonstrate why the bond was issued at face value ($5 million) by calculating the present value of both the principal and interest using Table P and Table 1. Record your response in an Excel document and upload below.

Answer 1

As a rule if the market rate and the interest rate of the bond is the same, then the value of the bond is the face value of the bond.

This means that $ 5 million if invested in market will give 4% interest every year. The same $ 5 million if invested in the bond will give the same 4% interest every year. The cash inflow and outflow is the same in both the cases. The present value of both the options is $ 5 million, i.e. the cash available today assuming discount rate is same as market rate of 4%.