Question

Scenario FOUR: A company has issued 10-year bonds, with a face value of $1,000. Interest at 8 % is paid quartery 17. If an investor has a nominal MARR 16 % , compounded quarterly, she will only purchase the bond if it sells at in the secondary market: a. Par value b. A premium The redemption price d. c. A discount 18. What are the quarterly interest payments on the bond? a. $40 b. $30 c. $20 d. $80 19. The most that an investor with a nominal MARR = 16 % , compounded quarterly, is willing to pay for this bond is: a. $722.97 b. $604.16 c. $509.83 d. $942.42

Answer 1

Option-(d): A discount 17) Reason: -->There is an inverse relationship between bond's coupon rate and yield to maturity (is nothing but the market interest rate) -->It results inverse relation exists between bond price and bond's market interest rate too. Bond's yield to maturity is nothing but the market interest rate or expected return on bond by investors. If the yield to maturity --> is higher than coupon rate, bonds will be issued at discount (market price less than bond's par value) to attract more customers; -->On the other hand, if the yield to maturity is lower than coupon rate, bonds will be issued at premium (market price more than bond's par value) as the bonds will be demanded more among the investors; -->If yield to maturity is equal to coupon rate, bonds will be issued at par obviously as both coupon rate and investor's expected exactly satisfies investors' expected return on such bonds. return rate are equal which implies that bond's coupon rate 18) Option-(c): $20 Reason: Coupon payments are payable at coupon rate mentioned on bonds payable by multiplying bond's face value by the same. As it is a quarterly coupon paying bond, annual coupon payment calculated shall be divided by 4 to calculate quarterly payment: $1,000 Face value of bonds payable Annual coupon payment 8% Number of quarters in a year 4 Quarterly coupon payment $20

4% [ 16%/4 as there are 4 quarters in a year] 19) Quarterly Interest rate, RATE 40 [10 years x 4 = 40 as there are 4 quarters per year] $20 [$1000 x 8%/4] #of quarters to maturity, NPER Quarterly interest payment, PMT $1,000 [Face value of the bond] Maturity value at the end, FV 0 0 if coupons paid at the end of each period; 1 if coupons paid at the beginning of each period. $604.14 [Ref: NOTE] --Option(b) Quarterly interest type, TYPE Price that investor must pay for this bond NOTE Price that investor must pay for this bond is calculated using EXCEL FUNCTION PV(rate,nper,pmt,fv,type) where rate- 4%; nper - 40; pmt--20; fv-1000; type-0. Here, value for pmt & fv are negative as they denote cash inflows; type = 0 because coupons paid at the end of each quarter only B A E F G H K 16 % / 4 [ 16 % / 4 as there are 4 quarters in a year] 1 Quarterly Interest rate, RATE 2 #of quarters to maturity, NPER -10*4 [10 years x 4 40 as there are 4 quarters per year] B4*8%/4 [$1000 x 8% /4] Quarterly interest payment, PMT $1,000 [Face value of the bond] 4 Maturity value at the end, FV 5 Quarterly interest type, TYPE 6 Price that investor must pay for this bond 0 =0 if coupons paid at the end of each period; 1 if coupons paid at the beginning of each period. =PV(B1,B2, B3, -B4, B5) [Ref: NOTE]