4. Bond valuation As Aa The process of bond valuation is based on the fundamental concept that the current price of a security can be determined by calculating the present value of the cash flows that the security will generate in the future. There is a consistent and predictable relationship between a bond's coupon rate, its par value, a bondholder's required return, and the bond's resulting intrinsic value. Trading at a discount, trading ata premium, and trading at par refer to particular relationships between a bond's intrinsic value and its par value. These result from the relationship between a bond's coupon rate and a bondholder's required rate of return. Remember, a bond's coupon rate partially determines the interest-based return that a bond reflects the return that a bondholder pay, and a bondholder's required return to receive from a given investment The mathematics of bond valuation imply a predictable relationship between the bond's coupon rate, the bondholder's required return, the bond's par value, and its intrinsic value. These relationships can be summarized as follows: When the bond's coupon rate is equal to the bondholder's required return, the bond's intrinsic value will equal its par value, and the bond will trade at par. When the bond's coupon rate is greater to the bondholder's required return, the bond's intrinsic value will its par value, and the bond will trade at a premium. When the bond's coupon rate is less than the bondholder's required return, the bond's intrinsic value will be less than its par value, and the bond will trade at For example, assume Liam wants to earn a return of 12.25 % and is offered the opportunity to purchase a $1,000 par value bond that pays a 10.50 % coupon rate (distributed semiannually) with three years remaining to maturity. The folowing formula can be used to compute the bond's intrinsic value: A B Intrinsic Value + + Complete the following table by identifying the appropriate corresponding variables used in the equation. Variable Value Variable Name Unknown A $1,000 B Semiannual required return to expect that Liam's potential bond investment is currently exhibiting an intrinsic value Based on this equation and the data,, it is greater than $1,000. Now, consider the situation in which Liam wants to earn a return of 14% , but the bond being considered for purchase offers a coupon rate of 10.50 % . Anain, assume that the hond pays semiannual intecest nayments and has three vears tn maturity, If vou mund the bond's intrinsic.value to .the
