Question

Company A is selling 20 year bonds with a $50,000 par value and an annual coupon rate of 6.25%. The price of Company B's bonds is currently $11,200. They offer a $10,000 par value and mature in 10 years. The coupon rate is 8% and coupon payments are made semi-annually. Further research suggests to you that both bonds, which are rated as A+, introduce the same risk to you as an investor.

What should be the price of a Company A bond, rounded to the nearest dollar?

ANSWER:

1) $49,559
2) $49,388
3) Par
4) $32,048
5) None of the above

Answer 1

Calculating Yield to Maturity of Bond B,

using TVM Calculation,

I = [PV = -11,200, FV = 10,000, N = 20, PMT = 400]

I = 0.0636

Calculating Price of Bond A,

using TVM Calculation,

PV = [FV = 50,000, PMT = 3,125, N = 20, I = 0.0636]

PV = $49,388