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The tables below show, respectively, the characteristics of two annual-pay bonds from the same issuer with the

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The tables below show, respectively, the characteristics of two annual-pay bonds from the same issuer with the same priority in the event of default, and spot interest rates. Neither bond€™s price is consistent with the spot rates. Using the information in these tables, recommend either bond A or bond B for purchase.

The tables below show, respectively, the characteristics of two

Spot Interest Rates
Term (Years) Spot Rates (Zero-Coupon)
1 ..............5%
2 ..............8
3..............11

Transcribed Image Text:

Bond Characteristics Bond A Bond B Coupons Maturity Coupon rate Yield to maturity Price Annual 3 years 10% 10.65% 98.40 Annual 3 years 696 10.75% 88.34

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ISBN: 9780073530703

9th Edition

Authors: Zvi Bodie, Alex Kane, Alan J. Marcus

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Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.

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