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5. 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 retum, and the band'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. This also results from the relationship between a bond's coupon rate and a bondholder's required rate of return. Remember, a band's coupon rate partially determines the interest-based return that a bond will reflects the return that a bondholder would like to receive from a given investment. pay, and a bondholder's required return 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 retum, the bond's intrinsic value will equal its par value, and the band will trade at par . When the band's coupon rate is greater than the bondholder's required return, the bond's intrinsic value will exceed 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 band's intrinsic value will be less than its par value, and the bond will trade at a discount Complete the following table by identifying the appropriate corresponding variables used in the equation Unknown Variable Value Variable Name Bond's semiannual coupon payment Bend's market price Semiannual required return B $1,000 2.5000% Based on this equation and the data, it is reasonable greater than $1,000 to expect that Tesla's potential bond investment is currently exhibiting an intrinsic value Now, consider the situation in which Tesfa wants to eam a return of 12%, but the bond being considered for purchase offers a coupon rate of 8.75 Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the band's intrinsic value to the nearest whole dollar, then its intrinsic value of $920 (rounded to the nearest whole dollar) is greater than its par value, so that the bond is trading at a premium Given your computation and conclusions, which of the following statements is true? When the coupon rate is greater than Teste's required return, the bond should trade at a premium. When the coupon rate is greater than Testa's required return, the bond's intrinsic value will be less than its par value A bond should trade at par when the coupon rate is greater than Testa's required return When the coupion rate is greater than Testa's required return, the band should trade at a discount What will happen to the price of a fixed-rate bond when expectations for inflation rise? The bond price will rise The bond price will fall. For example, assume Tesfa wants to earn a return of 5.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a 8.75% 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 - +++ Complete the following table by identifying the appropriate corresponding variables used in the equation Unknown A Variable Value Variable Name Band's semiannual coupon payment Bond's market price Semiannual required retum B $1.000 2.5000 Based on this equation and the data, it is reasonable greater than $1,000 to expect that Testos potential bond investment is currently exhibiting an intrinsic value Now, consider the situation in which Tesla wants to carn a return of 124, but the band being considered for Durchase Adanh
