Fundamentals of Financial Manageme...
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Fundamentals of Financial Manageme...
BOND VALUATION An investor has two bonds in his portfolio that have a face value of $1,000 and pay a 10% annual coupon. Bond L matures in 15 years, while Bond S matures in 1 year.
- a. What will the value of each bond be if the going interest rate is 5%, 8%, and 12%? Assume that only one more interest payment is to be made on Bond S at its maturity and that 15 more payments are to be made on Bond L.
- b. Why does the longer-term bond’s price vary more than the price of the shorter-term bond when interest rates change?
(a)
To identify: Current market price of bond.
Bond Valuation:
Bond valuation refers to the evaluation of bonds value at any point of time, which can be used for decision making. Valuation of bond is done for comparison and analysis.
Given,
Interest rate is 10% or 0.1.
Yield to maturity (YTM) is 5%,8% and 12%.
Par value of bond is $1,000.
Maturity is after 15 years for bond L.
Maturity is after 1 year for bond S.
Formula to calculate present value of bond,
(b)
To explain: Reasons for variation in price of longer-term bond and shorter-term bonds due to change in interest rate.
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