Assume you are evaluating whether to purchase the following $1,000 face value bo
ID: 2726948 • Letter: A
Question
Assume you are evaluating whether to purchase the following $1,000 face value bonds:
Co. X bond with a 6% coupon rate that matures in 9 years.
Co. Y bond with an 11% coupon rate that matures in 7 years.
Value these bonds assuming a market rate on similar risk bonds is 7% and interest is paid annually.
Value these bonds assuming a market rate on similar risk bonds is 7% and interest is paid semi-annually.
Value these bonds assuming a market rate on similar risk bonds is 12% and interest is paid annually.
Assuming both bonds were issued at the same time, why would the Co. Y bond pay a higher coupon rate?
Explanation / Answer
Interest is paid annually:
Value of bond X
Year
Cash flows
Present value factor at 7%
PV of cash flows
1
60
0.9346
56.076
2
60
0.8734
52.404
3
60
0.8163
48.978
4
60
0.7629
45.774
5
60
0.7130
42.780
6
60
0.6663
39.978
7
60
0.6227
37.362
8
60
0.5820
34.920
9
60
0.5439
32.634
9
1,000
0.5439
543.900
Total
$934.806
The value of bond X is $934.81
Value of bond X
Year
Cash flows
Present value factor at 7%
PV of cash flows
1
110
0.9346
102.806
2
110
0.8734
96.074
3
110
0.8163
89.793
4
110
0.7629
83.919
5
110
0.7130
78.43
6
110
0.6663
73.293
7
110
0.6227
68.497
7
1,000
0.5820
582
Total
1,174.812
The value of bond Y is $1,174.81
Year
Cash flows
Present value factor at 7%
PV of cash flows
1
60
0.9346
56.076
2
60
0.8734
52.404
3
60
0.8163
48.978
4
60
0.7629
45.774
5
60
0.7130
42.780
6
60
0.6663
39.978
7
60
0.6227
37.362
8
60
0.5820
34.920
9
60
0.5439
32.634
9
1,000
0.5439
543.900
Total
$934.806