Chapter 6, Problem 9PROB

Summary Introduction

Bond L has a face value of $1,000 with annual interest rate of $100, matures in 15 years with rate of interest of a) 5 percent and b) 7 percent. Bond S also has a face value of $1,000 and an annual interest rate of $100, matures in 15 years with rate of interest of a) 5 percent and b) 7 percent.

Bonds are issued to raise funds for the company. The important characteristic of a bond is that it has a maturity value which is the value the bondholders will get at the end of the maturity period. Also, some bonds carry coupon rate which means the bondholders will get a regular interest cash flow on that bond.

The yield to maturity (YTM) of the bond is the required rate of return investors expect on holding the bond till the maturity period.

Bond Price is calculated as

$\begin{array}{c}\text{Bond Price}\left(V_d\right)\text{ = }{\displaystyle \sum \frac{IN{T}_N}{{\left(1+r_d\right)}^N}+\frac{M}{{\left(1+r_d\right)}^N}}\\ or,V_d=INT\left(\frac{1-\frac{1}{{\left(1+r_d\right)}^N}}{r_d}\right)+M\left(\frac{1}{{\left(1+r_d\right)}^N}\right)\end{array}$

Where,

INT = coupon payments made

N = number of periods

M = Maturity or Face value

rd = rate of return

Vd = Value of the bond