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pay, and a bondholder's required 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 Remember, a bond's coupon rate partially determines the interest-based return that a bond reflects the return that a bondholder 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 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 its par For example, assume Ella wants to earn a return of 8.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a 14.00% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bond's intrinsic value: Intrinsic Value (1#CJI + (1+C)2 + (14)3 + (1 6634 + (1+cj$ + (1+Cj6 + 1 hecho Complete the following table by identifying the appropriate corresponding variables used in the equation. Unknown Variable Name Variable Value B $1,000 Semiannual required return to expect that Ella'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 Ella wants to earn a return of 12.00%, but the bond being considered for purchase offers a coupon rate of 14.00%. 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 (rounded to the nearest whole dollar) is its par value, so that the
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