Company X has the following bonds outstanding: Initially, both bonds sold at $1,000 with yields to maturity
Question:
Company X has the following bonds outstanding:
Initially, both bonds sold at $1,000 with yields to maturity of 8 percent.
a) After two years, the interest rate on comparable debt is 10 percent. What should be the price of each bond?
b) After two additional years (i.e., four years after issue date), the interest rate on comparable debt is 7 percent. What should be the price of each bond?
c) What generalization may be drawn from the prices in questions (a) and(b)?
Bond A Bond B Coupon Variable-changes annually to be comparable Coupon 8% Maturity 10 years to the current rate Maturity 10 years
Step by Step Answer:
a Two years have lapsed the term is now eight years P A 80 80 80 1000 1 1 1 1 2 1 1 8 1 1 8 805335 1...View the full answer
Related Video
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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