Question

Bond value and changing required returns Midland Utilities has a bond issue outstanding that will mature to its $1.000 par value in 13 years. The bond has a coupon interest rate of 13% and pays interest annually a. Find the value of the bond if the required retumis (1) 13%. (2) 17%, and (3) 10% b. Use your finding in part a and the graph here to discuss the relationship between the coupon interest rate on a bond and the required return and the market value of the bond relative to its par value. c. What iwo possible reasons could cause the required return to differ from the coupon interest rate? a. (1) The value of the bond, if the required return is 13%, is $ . (Round to the nearest cent) (2) The value of the bond, if the required return is 17%, is $ (Round to the nearest cent.) (3) The value of the band, in the required return is 10%, is $ . (Round to the nearest cent.) b. Use your finding in part a and the graph here to answer the following questions: (Select from the drop down menus.) When the required return is less than the coupon rate the market value is the par value. When the required return is equal to the coupon rate the market value is the par value When the required return is greater than the coupon rate, the market value is the par value e. What two possible reasons could cause the required return to differ from the coupon interest rate? (Select the best answe A. Bond contract has changed B. Tax rate has changed c. Firm's risk has changed Click to select your answers

Answer 1

Value of bond is equal to the present value of all future coupon payments and the principal amount

a.At 13%

= 1000*13%*PVAF(13%, 13 years) + 1,000*PVF(13%, 13 years)

= 130*6.1218 +1,000*0.2042

= $1,000.03

2.17%

= 130*5.1183 +1,000*0.1299

= $795.28

3.At 10%

= 130*7.1033 + 1,000*0.2897

= $1,213.13

Higher than par

Equal to par

Below par

Reasons:

C.Firm’s risk has changed