8. Bond valuation 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 at a 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 qual its par value, and the bond at par. . When the bond's coupon rate is greater to the bondholder's required return, the bond's intrinsic s required return, the bond's intrinsic value will v its par value, and the bond will trade at a premium. . when the bond's coupon rate is less than th e bondholders required return, the bond's intrinsic value will be less than its par value, and the bond will trade for example, assume Oliva wants to earn a return of coupon value: 9.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a sou rate (distribut ted semiannually) with three years remaining to maturity. The following formula can be used to compute the bond's intrinsic omplete the following table by identifying the appropriate corresponding variables used in the equation. Unknown Variable Name Variable Value $1,000 Semiannual required return Based on this equation and the data, it is $1,000. M to expect that Olivia's potential bond investment will exhibit an intrinsic value less thar Now, consider the situation in which Olivia wants to earn a return of 10% but the bond being considered for purchase offers a coupon rate of 12% Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the bond's intrinsic value to the nearest whole dollar, then its intrinsic value of its par value, so that the bond is trading at is Given your computation and condusions, which of the following statements is true? O When the coupon rate is greater than Olivia's required return, the bond's intrinsic value will be less than its par value. O When the coupon rate is oreater than Olivia's required return, the bond should trade at a premium. 0 when the coupon rate is greater than Olivia's required return, the bond should trade at a discount. - A bond should trade at a par when the coupon rate is greater than Olivia's required return. Intrinsic Value-(1+4' + (1+47 +-+-+ (1+-+-+ (HB- Complete the following table by identifying the appropriate corresponding variables used in the equation Unknown Variable Name Variable Value $1,000 Bondholder's required return Bond's market price Bond's semiannual coupon payment Based on this e $1,000. to expect that Olivia's potential bond investment will Now, consider the situation in which Olivia wants to earn a return of 10%, but the bond being considered for purchas Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the b nearest whole dollar, then its intrinsic value of ofccIsRREits par value, so that the bond is trae Given your computation and conclusions, which of the following statements is true? 9 When the coupon rate is greater than Olivia's required O When the coupon rate is greater than Olivia's required retu O When the coupon rate is greater than Olivia's required return, the bond should trade at a O A bond should trade at a par when th return, the bond's intrinsic value will be less than its p rn, the bond should trade at a premium. e coupon rate is greater than Olivia's required return