Question

A coupon bond that pays interest annually has a par value of $1,000, matures in six
years, and has a yield to maturity of 11%. The intrinsic value of the bond today will be
________ if the coupon rate is 7.5%.

A) $886.28
B) $851.93
C) $1,123.01
D) $1,000.00
E) $712.99

Answer 1

The closest answer out of given options is:

B) 851.93

The cash flows that will occur over a period of six years include 1000 at the end of 6th year which is part value of the bond and 7.5 percent on par value as interest every year.

Hence cash flows for year 1, 2, 3, 4, 5 and 6 will be 75, 75, 75, 75, 75 and 1075 respectively. Here 1075 is interest for 6th year plus par value i.e. 75+1000.

These cash flows discounted at the rate of 11 percentage will give $ 846.5. The closest for this among the options is $ 851.93. PV formula maybe used in Excel to arrive at present value of each of the six cash flows where nper will be the year in which cash flow happens and f.v. will be the amount of cash flow. Rate will be 0.11.