Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

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

image text in transcribed
image text in transcribed
image text in transcribed
image text in transcribed
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 secunty 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 bond's resulting intrinsic value. Trading at a dscount, 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 bendholder's required rate of return. Remember, a bond's coupon rate partially determines the interest-based retum that a bond pay, and a bondholder's required return reflects the return that a bondholder 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 bond will trade at par. - When the bond's coupon rate is greater than 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 Noah wants to eam a return of 15.75% and is offered the opportunity to purchase a $1,000 par value bond that pays a 13.50% 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+C)2A+(1+C)2A+(1+C)3A+(1+C)2A+(1+C)3A+(1+C)6A+(1+C)4B Complete the following table by identifying the appropriate corresponding variables used in the equation. Based on this equation and the data, it is to expect that Noahis potental bond investment is curfently exhibiting an intrinsic value greater than $1,000. Now, conseder the situation in which Noah wants to earn a return of 11.50%, but the bond being considered for purchase offers a coupon rate of 13.50\%. Again, assume that the bond pays semannual ieterest payments and has three years to matunty. If you round the bond intrinsic value to the nearest whole dollar, then its intrnosic value of (rounded to the nearest whole dollar) is its par value, so that the bond is Now, consider the situation in which Noah wants to earn a return of 11.50%, but the bond being considered for purchase offers a coupon rate of 13.50\%. 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 bond is Given your computation and condusions, which of the following statements is true? A bond should trade at a par when the coupon rate is greater than Noah's required return. When the coupon rate is greater than Noah's required return, the bond's intrinsic value will be less than its par value. When the coupon rate is greater than Noah's required return, the bond should trade at a discount. When the coupon rate is greater than Noah's required return, the bond should trade at a premium

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Legal Aspects Of Trade Finance

Authors: Charles Chatterjee

1st Edition

1857433890, 978-1857433890

More Books

Students also viewed these Finance questions

Question

What advice would you provide to Jennifer?

Answered: 1 week ago

Question

What are the issues of concern for each of the affected parties?

Answered: 1 week ago