Question

8. 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. These result 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 bond reflects the return that a bondholder pay, and a bondholder's required return 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 qual its par value, and the bond at par. . When the bond's coupon rate is greater to the bondholder's required return, the bond's intrinsic s required return, the bond's intrinsic value will v its par value, and the bond will trade at a premium. . when the bond's coupon rate is less than th e bondholders required return, the bond's intrinsic value will be less than its par value, and the bond will trade for example, assume Olivía wants to earn a return of coupon value: 9.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a sou rate (distribut ted semiannually) with three years remaining to maturity. The following formula can be used to compute the bond's intrinsic

Answer 1

Answer ) Remember , a bond’s coupon rate partially determines the interest based return that a bond actual pay, and a bondholder’s required return reflects the return that a bondholder expected to receive from a given investment.

Answer 2) a. More than

b.   discount.

Answer 3)

Unknown	Variable Name	Variable Value
A	Bond's Semiannual coupon payment	$1000*(7.5/2%)	$38
B	Bond's Market price		$1,000
C	Bondholder's required return		9%

a) $963.89

calculated below:as

n(time)	A(cash flow)	PV @ C 4.5% semi annual
1	38	36.36363636
2	38	34.79773815
3	38	33.29927095
4	38	31.86533106
5	38	30.49313977
6	38	29.18003805
6	1000	767.8957383
	Intrinsic value	963.8948926

Answer ) In next situation ,

Intrinsic value : $1077.37

More than its par value ,

trading at Premium.

Intrinsic value calculated below as:

n(time)	A(cash flow) at coupon rate of 12%	PV @ C 5% semi annual
1	60	57.41626794
2	60	54.94379707
3	60	52.57779624
4	60	50.31368062
5	60	48.14706279
6	60	46.0737443
6	1000	767.8957383
	Intrinsic value	1077.368087