For example, assume Ella wants to earn a return of 8.00% and is offered the opportunity to purchase a $1,000 par value bond that pays an 8.00% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bond’s intrinsic value: Intrinsic Value = A(1+C)1+A(1+C)2+A(1+C)3+A(1+C)4+A(1+C)5+A(1+C)6+B(1+C)6 Q(1)Complete the following table by identifying the appropriate corresponding variables used in the equation. Unknown Variable Name Variable Value A _____(Need answer here) _____(Need answer here) B _____(Need answer here) $1,000 C Semiannual required return _____(Need answer here) Based on this equation and the data, it is Q(2)______ to expect that Ella’s potential bond investment is currently exhibiting an intrinsic value equal to $1,000. Now, consider the situation in which Ella wants to earn a return of 11%, but the bond being considered for purchase offers a coupon rate of 8.00%. Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the bond’s intrinsic value to the nearest whole dollar, then its intrinsic value ofQ(3)______(rounded to the nearest whole dollar) is Q(4) _______ its par value, so that the bond is Q(5)_______ Q(6) Given your computation and conclusions, which of the following statements is true? a. When the coupon rate is less than Ella’s required return, the bond should trade at a discount. b. When the coupon rate is less than Ella’s required return, the intrinsic value will be greater than its par value. c. When the coupon rate is less than Ella’s required return, the bond should trade at a premium. d. A bond should trade at par when the coupon rate is less than Ella’s required return. Please answer the fill in the blanks of Q1, Q2, Q3. The options are provided below: Q1. A. Variable name: Option 1. Bondholder's required return or Option 2. Bond's annual coupon payment or Option 3. Bond's semiannual coupon payment. B. Variablename: Option 1. Bond's par value or Option 2 Bond's Market price or Option 3 Bond's annual coupon payment. C. Variable value: Option 1. 5.7525% Option 2. 6.5000% or Option 3 3.8125% or Option 4.0000%. Q2. Option 1. Reasonable or Unreasonable Q3. Option 1. $1,203 or Option 2 $740, Option 3 $925 or Option 4 $648 Q4. Option 1. Less than or Option 2 Greater than or Option 3 Equal to. Q5. Option 1. Trading at a discount or Option 2 Trading at a premium or Option 3 Trading at Par. Q6. Please check the options given in Q6.

For example, assume Ella wants to earn a return of 8.00% and is offered the opportunity to purchase a $1,000 par value bond that pays an 8.00% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bond’s intrinsic value: Intrinsic Value = A(1+C)1+A(1+C)2+A(1+C)3+A(1+C)4+A(1+C)5+A(1+C)6+B(1+C)6 Q(1)Complete the following table by identifying the appropriate corresponding variables used in the equation. Unknown Variable Name Variable Value A ___(Need answer here) _(Need answer here) B _(Need answer here) $1,000 C Semiannual required return _(Need answer here) Based on this equation and the data, it is Q(2) to expect that Ella’s potential bond investment is currently exhibiting an intrinsic value equal to $1,000. Now, consider the situation in which Ella wants to earn a return of 11%, but the bond being considered for purchase offers a coupon rate of 8.00%. Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the bond’s intrinsic value to the nearest whole dollar, then its intrinsic value ofQ(3)(rounded to the nearest whole dollar) is Q(4) _ its par value, so that the bond is Q(5)___ Q(6) Given your computation and conclusions, which of the following statements is true? a. When the coupon rate is less than Ella’s required return, the bond should trade at a discount. b. When the coupon rate is less than Ella’s required return, the intrinsic value will be greater than its par value. c. When the coupon rate is less than Ella’s required return, the bond should trade at a premium. d. A bond should trade at par when the coupon rate is less than Ella’s required return. Please answer the fill in the blanks of Q1, Q2, Q3. The options are provided below: Q1. A. Variable name: Option 1. Bondholder's required return or Option 2. Bond's annual coupon payment or Option 3. Bond's semiannual coupon payment. B. Variablename: Option 1. Bond's par value or Option 2 Bond's Market price or Option 3 Bond's annual coupon payment. C. Variable value: Option 1. 5.7525% Option 2. 6.5000% or Option 3 3.8125% or Option 4.0000%. Q2. Option 1. Reasonable or Unreasonable Q3. Option 1. $1,203 or Option 2 $740, Option 3 $925 or Option 4 $648 Q4. Option 1. Less than or Option 2 Greater than or Option 3 Equal to. Q5. Option 1. Trading at a discount or Option 2 Trading at a premium or Option 3 Trading at Par. Q6. Please check the options given in Q6.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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4. Bond valuation

The process of bond valuation is based on the fundamental concept that the current price of a security can be determined by calculating the present value of the cash flows that the security will generate in the future.

There is a consistent and predictable relationship between a bond’s coupon rate, its par value, a bondholder’s required return, and the bond’s resulting intrinsic value. Trading at a discount, trading at a premium, and trading at par refer to particular relationships between a bond’s intrinsic value and its par value. This also results from the relationship between a bond’s coupon rate and a bondholder’s required rate of return.

Remember, a bond’s coupon rate partially determines the interest-based return that a bondwill pay, and a bondholder’s required return reflects the return that a bondholderis obligated to receive from a given investment.

The mathematics of bond valuation imply a predictable relationship between the bond’s coupon rate, the bondholder’s required return, the bond’s par value, and its intrinsic value. These relationships can be summarized as follows:

•	When the bond’s coupon rate is equal to the bondholder’s required return, the bond’s intrinsic value will equal its par value, and the bond will trade at par.
•	When the bond’s coupon rate is greater than the bondholder’s required return, the bond’s intrinsic value will exceed its par value, and the bond will trade at a premium.
•	When the bond’s coupon rate is less than the bondholder’s required return, the bond’s intrinsic value will be less than its par value, and the bond will trade ata discount .

Intrinsic Value

A(1+C)1+A(1+C)2+A(1+C)3+A(1+C)4+A(1+C)5+A(1+C)6+B(1+C)6

Q(1)Complete the following table by identifying the appropriate corresponding variables used in the equation.

Unknown	Variable Name	Variable Value
A	_____(Need answer here)	_____(Need answer here)
B	_____(Need answer here)	$1,000
C	Semiannual required return	_____(Need answer here)

Based on this equation and the data, it is Q(2)______ to expect that Ella’s potential bond investment is currently exhibiting an intrinsic value equal to $1,000.

Now, consider the situation in which Ella wants to earn a return of 11%, but the bond being considered for purchase offers a coupon rate of 8.00%. Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the bond’s intrinsic value to the nearest whole dollar, then its intrinsic value ofQ(3)______(rounded to the nearest whole dollar) is Q(4) _______ its par value, so that the bond is Q(5)_______

Q(6) Given your computation and conclusions, which of the following statements is true?

a. When the coupon rate is less than Ella’s required return, the bond should trade at a discount.

b. When the coupon rate is less than Ella’s required return, the intrinsic value will be greater than its par value.

c. When the coupon rate is less than Ella’s required return, the bond should trade at a premium.

d. A bond should trade at par when the coupon rate is less than Ella’s required return.

Please answer the fill in the blanks of Q1, Q2, Q3. The options are provided below:

Q1. A. Variable name: Option 1. Bondholder's required return or Option 2. Bond's annual coupon payment or Option 3. Bond's semiannual coupon payment. B. Variablename: Option 1. Bond's par value or Option 2 Bond's Market price or Option 3 Bond's annual coupon payment. C. Variable value: Option 1. 5.7525% Option 2. 6.5000% or Option 3 3.8125% or Option 4.0000%.

Q2. Option 1. Reasonable or Unreasonable

Q3. Option 1. $1,203 or Option 2 $740, Option 3 $925 or Option 4 $648

Q4. Option 1. Less than or Option 2 Greater than or Option 3 Equal to.

Q5. Option 1. Trading at a discount or Option 2 Trading at a premium or Option 3 Trading at Par.

Q6. Please check the options given in Q6.

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