For example, assume Sophia wants to earn a return of 7.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a 7.00% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bond’s intrinsic value: Intrinsic ValueIntrinsic 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)6A1+C1+A1+C2+A1+C3+A1+C4+A1+C5+A1+C6+B1+C6 Complete the following table by identifying the appropriate corresponding variables used in the equation. Unknown Variable Name Variable Value A Bond’s semiannual coupon payment B Bond’s par value $1,000 C Semiannual required return Now, consider the situation in which Sophia wants to earn a return of 5.00%, but the bond being considered for purchase offers a coupon rate of 7.00%. 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 of_____ (rounded to the nearest whole dollar)is_its par value, so that the bond is _____. Given your computation and conclusions, which of the following statements is true? A. When the coupon rate is greater than Sophia’s required return, the bond should trade at a premium. B. A bond should trade at a par when the coupon rate is greater than Sophia’s required return. C. When the coupon rate is greater than Sophia’s required return, the bond should trade at a discount. D. When the coupon rate is greater than Sophia’s required return, the bond’s intrinsic value will be less than its par value.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 9P

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For example, assume Sophia wants to earn a return of 7.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a 7.00% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bond’s intrinsic value:

Intrinsic ValueIntrinsic 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)6A1+C1+A1+C2+A1+C3+A1+C4+A1+C5+A1+C6+B1+C6

Complete the following table by identifying the appropriate corresponding variables used in the equation.

Unknown	Variable Name	Variable Value
A	Bond’s semiannual coupon payment
B	Bond’s par value	$1,000
C	Semiannual required return

Now, consider the situation in which Sophia wants to earn a return of 5.00%, but the bond being considered for purchase offers a coupon rate of 7.00%. 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 of_________ (rounded to the nearest whole dollar)is_______its par value, so that the bond is _______.

Given your computation and conclusions, which of the following statements is true?

A. When the coupon rate is greater than Sophia’s required return, the bond should trade at a premium.

B. A bond should trade at a par when the coupon rate is greater than Sophia’s required return.

C. When the coupon rate is greater than Sophia’s required return, the bond should trade at a discount.

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

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