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Premier Textbooks, Ltd. Premier Textbooks has been a leader in elementary textbooks for over 25 years. Recently, you received a bonus of $10,000 from your company, which had their best year in 5 years. You would like to invest in bonds with a good, solid company and are considering Premier Textbooks. Recently, Premier has offered a new 15-year bond issue of $500,000, with a par value of $1000 per bond. They pay 5.5 percent interest and the current market price for these bonds is $1085. Your required rate of return is 7%.
Required:
a- Compute the bond’s expected rate of return.
b- Calculate the value of the bond to you, given your required rate of return.
c- Should you purchase the bond? Explain.
d- Name at least 2 other facts about this or any other bond you might consider buying that would help you decide on whether you should buy the bond.
a- Bond’s expected rate of return.
Bond's Expected rate of return = Interest rate on bond = 5.5%
Interest = 5.5% of 1000= 55
Current market price of Bond = 1085
Period 15%
Bond’s expected rate of return = [Interest p.a.+ (Face Value - Current market price ) /Period] / [(Face Value + Current market price) /2]
Interest/ Current market price
=($55+ ($1000-$1085)/15)/(($1085+$1000)/2) = 4.732%
b- Value of the bond as per required rate of return of 7%
Required rate of return 7%
| Year | Amount received | Present Value Factor | Present Value | ||
| 1 | 55 | 0.9346 | 51.4019 | ||
| 2 | 55 | 0.8734 | 48.0391 | ||
| 3 | 55 | 0.8163 | 44.8964 | ||
| 4 | 55 | 0.7629 | 41.9592 | ||
| 5 | 55 | 0.7130 | 39.2142 | ||
| 6 | 55 | 0.6663 | 36.6488 | ||
| 7 | 55 | 0.6227 | 34.2512 | ||
| 8 | 55 | 0.5820 | 32.0105 | ||
| 9 | 55 | 0.5439 | 29.9164 | ||
| 10 | 55 | 0.5083 | 27.9592 | ||
| 11 | 55 | 0.4751 | 26.1301 | ||
| 12 | 55 | 0.4440 | 24.4207 | ||
| 13 | 55 | 0.4150 | 22.8230 | ||
| 14 | 55 | 0.3878 | 21.3299 | ||
| 15 | 55 | 0.3624 | 19.9345 | ||
| 15 | 1000 | 0.3624 | 362.4460 | ||
| Value of the bond as per required rate of return | 863.3813 | ||||
c- Should we purchase the bond
Current market price of Bond = $1085
Value of the bond as per required rate of return = $863.38
We should not purchase the bond as the Value of bond is less than the Current market price of bond. Thus bond is overvalued and we should not purchase the bond.
d- Other facts about the bond that would help us decide on whether we should buy the bond.
1.Credit Rating - Credit rating is assigned by Credit rating agency (ICRA, Moody). If credit rating is higher, issuer is more likely to meet the payment obligation of time. It is based on risk profile of company and bond
2. Inflation - .When Inflation rise Price of bond decreases .It makes the intrest rate to go up and on other side bond value will reduce.
3. Buy Back Optionof bond Issuer - This allow issuer to redeem bonds before maturity based on the market condition .So investor might consider this factor while investing in to any bond.
4. Convertible option in bond
