OQ1 Various Interest Rate Measures Q1a. (Example 3-1) A Walmart bond you purchased two years ago for $890 is now selling for $925. The bond paid $100 per year in coupon interest on the last day of each year (the last payment made today). You intend to hold the bond for four more years and project that you will be able to sell it at the end of year 4 for $960. You also project that the bond will continue paying $100 in interest per year. Given the risk associated with the bond, its required rate of return (r) over the next four years is 11.25 percent. Should you sell this bond? PV = $100 + $100 + $100 + = $935.31 $100 + $960 (1 + 0.1125)1 (1 + 0.1125) (1 + 0.1125) (1 + 0.1125)4 Given the current selling price of the Walmart bond, $925, relative to the fair present value, $935.31, this bond is currently undervalued. You should not sell this bond now. Q1b. (Example 3-2) Refer to information in Example 31 describing a Walmart bond you purchased two years ago for $890. Using the current market price of $925, what is the expected rate of return? Should you sell this bond? $925 = $100 $100 + $100 (1 + E(r)) (1 + E(r)) (1 + E(r)) E(r) = 11.61% $100 + $960 + (1 + E(r))4 As the required return on the bond is 11.25%, the projected cash flows on the bond are greater than is required to compensate you for the risk on the bond.