(Bond valuation) Fingen's 14-year, $1,000 par value bonds pay 8 percent interest annually. The market price of the bonds is $1,130 and the market's required yield to maturity on a comparable-risk bond is 5 percent.
a. Compute the bond's yield to maturity.
b. Determine the value of the bond to you, given your required rate of return.
c. Should you purchase the bond?
round to two decimal places.
a. Compute the bond's yield to maturity.
Yield To Maturity(YTM) = (interest per annum + (Redemption price - Current market price) / life remaining to maturity) / (.4*Redemption price)+ (.6*Current market price)
= (1000*8%)+)(1000-1130)/14)/(.4*1000+.6*1130)
= (80-9.28571428571)/1078
= 6.55%
b. Determine the value of the bond to you, given your required rate of return.
Bond Valuation: The value of bond is the present value of the expected cashflows from the bond,discounted at Yield to Maturity(YTM).
Year | Cash flow | PVAF/PVF@5% | Present Value (Cashflow*PVAF/PVF) |
1-14 | 80 | 9.8986 | 791.89 |
14 | 1000 | 0.5051 | 505.07 |
Current Market Price of Bonds = Cashflow*PVAF/PVF
= 791.89+505.07
= $1296.96
*PVAF = (1-(1+r)^-n)/r
**PVF = 1 / (1+r)^n
c. Should you purchase the bond?
Here actual price ($1,130) < Fair price ($1,296.96), so the bond is undervalued, purchase the bonds.
(Bond valuation) Fingen's 14-year, $1,000 par value bonds pay 8 percent interest annually. The market price...
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