Question

1. Magongo Ltd has in issue a 16% bond with a par value of sh. 1000. The bond is redeemable in 4 years at par value and pays interest to the holders at the end of every year. Current market interest rate is 15% and the bond is trading at sh. 1080.

Required

1. Intrinsic value of the bond                                                                                  (4 marks)

2. Advice a holder of the bond on whether to sell it at the current market price (2 marks)

Answer 1

	i) Calculation of intrinsic value of the bond
	a	Annual Interest Payment				$          160.00
		($1000*16%)
	b	PVAIF (15%, 4 Years)				2.8550
	c	Present Value Of Interest Payment				$          456.80
	d	PVF (15%, 4 Year)				0.572
	e	Present Value Of Redemption Amount				$          571.75
		(d*1000)
	f	Intrinsic Value Of Bond				$      1,028.55
		(c+e)
	ii)	Current Selling Price = $1028.55
		Intrinsic Value		=1028.55
		Bonds have overvalued hence the holder should sell at the current market price.