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An investor is building a portfolio of medium-quality, two-year, zero coupon corporate bonds. She uses time...

An investor is building a portfolio of medium-quality, two-year, zero coupon corporate bonds. She uses time value equations Opportunity Investment Model to analyze potential purchases. She measures project-specific-risk in future cash flows, and she believes that the project-risk-adjusted CF2 for a prospective bond is 96. The promised CF2 for this bond is $100. The annualized risk-free rate (rrf) for two-year bonds is 2%. If she thinks she should pay just $80 for the bond today, what annual discount rate (r) did she use to get this value?

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Answer #1

ZERO COUPON BOND FORMULA FOR CALCULATING PRESENT VALUE/INTRINSIC VALUE (IV)

IV= FAIR VALUE/(1+R)n

80= 100/(1+r)(1+r)

r =11.8

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