Question

5. A $1,000 bond has no maturity pays a 4% coupon rate and requires a 6.25% return. What is the price of the bond?

Answer 1

Interest Rate - 4%

Future Value= $1000

Required Rate - 6.25%

Coupon Payment - $40 (i.e $1000*4%)

Using Gordon growth rate to find the Pricing of Bond

Price = Cash Flows * (1 + g) / (r - g)

here , Cash Flow = Coupon Payments

g= growth rate

r = required rate

thus Cash Flow = $40

r - 6.25%

g= 0 % because the coupon payment will be fixed and their will be no growth in coupon payments

Thus Price = 40 / (6.25%- 4 %)

= 40 / 2.25%

=$1777.78

Thus the price of bond which is has no maturity with 4% coupon rate and 6.25% required rate will be trading @ $1777.8