Question

Problem 3 - Bonds

Suppose we sell an 8 year bond, with coupon rate =7 %.

The face value of the Bond is $1000. The market rate is 8 %.

1. What is the price of the bond ?

2. What is the interest expense in the first two years ?

Answer 1

1. Price of Bond = Cupon Amount * Present Value of Annuity Factor (r,n) + Redemption Amount * Present Value of Interest Factor (r,n)

Where Cupon Amount = $1000 * 7%

= $70

Redemption Amount = $1000

r = 8%

n = 8 years

Present Value of Annuity Factor (8% ,8) = 5.7466

Present Value of Interest Factor (8% ,8) = 0.5403

Therefore

Bond Price = $70 * 5.7466 + $1000 * 0.5403

Bond Price =$402.262 + $540.3

Bond Price = $942.562

2. Interest Expense in the first two years

Year 1 - Cupon Rate * Principal Amount

Year 1 - 7% * $1000

Year 1 - $70

Year 2 - 7% * $1000

Year 2 - $70

Total interest expense for the first two years = $70 +$70

= $140