Question

David Davis just received a cash gift from his grandfather. He plans to invest in a five-year bond issued by Pharoah Corp. that pays an annual coupon rate of 6.0 percent. If the current market rate is 10.00 percent, what is the maximum amount David should be willing to pay for this bond? (Round answer to 2 decimal places, e.g. 15.25.)

David should pay:

Answer 1

Annual coupon=$1000*6%=$60

Hence price of bond=Annual coupon*Present value of annuity factor(10%,5)+$1000*Present value of discounting factor(10%,5)

=$60*3.790786769+$1000*0.620921323

=$848.37(Approx).

NOTE:

1.Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=$60[1-(1.1)^-5]/0.1

=$60*3.790786769

2.Present value of discounting factor=$1000/1.1^5

=$1000*0.620921323