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Before you begin the bond, determine if the bond will sell at a discount, a premium,...

Question

Before you begin the bond, determine if the bond will sell at a discount, a premium,...

Before you begin the bond, determine if the bond will sell at a discount, a premium, or at par. Find the price of the floowing bond:

Coupon rate of 8.75%

pays semiannual coupons,

Face value of $1000

risk-adjusted rate of 8.0%,

and 10 years to maturity

Answers

The Bond is selling at PREMIUM

· If the coupon rate of a bond is above the current market interest rates, a bond will sell at Premium.

· When pricing bonds, there is an inverse relationship between the Market price and market interest rate or Yield to Maturity of the Bond

· The Market Price of the Bond is the Present Value of the Coupon Payments plus the Present Value of the face Value

· If the Market Interest Rate Increases, then the discounting rate will be higher & the discounting factor will be lower and it will result’s in the Market Price of the Bond to be lower.

· If the Market Interest Rate Decreases, then the discounting rate will be lower & the discounting factor will be higher and it will result’s in the Market Price of the Bond to be higher.

· If the Yield to Maturity [YTM] is greater than the coupon rate, then the selling price of the bond will be less than its par value, since the bonds are selling at discount.

· If the Yield to Maturity [YTM] is less than the coupon rate, then the selling price of the bond will be more than its par value, since the bonds are selling at premium.

Price of the Bond

· The Price of the Bond is the Present Value of the Coupon Payments plus the Present Value of the Face Value/Par Value.

· The Price of the Bond is normally calculated either by using EXCEL Functions or by using Financial Calculator.

· Here, the calculation of the Bond Price using financial calculator is as follows

Variables

Financial Calculator Keys

Figure

Par Value/Face Value of the Bond [$1,000]

FV

1,000

Coupon Amount [$1,000 x 8.75% x ½]

PMT

43.75

Market Interest Rate or Yield to maturity on the Bond [8.00% x ½]

1/Y

4.00

Maturity Period/Time to Maturity [10 Years x 2]

N

20

Bond Price

PV

?

Here, we need to set the above key variables into the financial calculator to find out the Price of the Bond. After entering the above keys in the financial calculator, we get the Price of the Bond (PV) = $1,050.96.

“Hence, the price of the Bond will be $1,050.96”


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