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BOND VALUATION You are considering a 10-year, $1,000 par value bond
BOND VALUATION You are considering a 10-year, $1,000 par value bond.
Its coupon rate is 9%, and interest is paid semiannually.
If you require an "effective" annual interest rate (not a nominal rate) of 8.16%, how much should you be willing to pay for the bond?
Expert Solution
Computation of the price of bond:-
Price of bond = (Coupon payment*((1-1/(1+rate)^n)/rate))+(FV/(1+rate)^n)
Here,
Coupon payment = $1,000*9%/2 = $45
n = 10*2 = 20 periods
rate = (1+EAR)^(1/n)-1
= (1+8.16%)^(1/2)-1
= 1.0400 - 1
= 4.00%
Price of bond = ($45*((1-1/(1+4%)^20)/4%))+($1,000/(1+4%)^20)
= ($45*13.5903)+($1,000/2.1911)
= $611.56 + $456.39
= $1,067.95
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