5. To fund a new train route a city decides to issue bonds. They issue bonds at
ID: 1121248 • Letter: 5
Question
5. To fund a new train route a city decides to issue bonds. They issue bonds at the start of 2018 with a face value of S10,000 and $100 coupon payments that are to be made at the end of 2018, 2019 and 2020. At the end of 2020 the city will also pay back the principle of the bond to investors. a) What is the rate of interest on the bond? b) If the discount rate is 2% what is the present value of the bond? c) If t is the start of 2019 and the 2019 coupon payment has 2019 given a discount rate of 2%? d)If other similar investments start offering a rate of interest that is higher than this bond, what do you expect the city to change about their bond and why?Explanation / Answer
5.
A.
Interest rate upon the bond = coupon payment/ face value = 100/10000
Interest rate upon the bond = 1%
B.
Time n = 3 years
R = 2%
Coupon payment = $100
Present value of the bond = present value of coupon payment + present value of the face value
Present value of the bond = 100*(1-1/1.02^3)/.02 + 10000/1.02^3
Present value of the bond = $9711.61
C.
Present value of the bond (at the beginning of 2019) = 100/1.02 + 10000/1.02
Present value of the bond (at the beginning of 2019) = $9901.96
D.
In a scenario of the other investments making higher interest payment, investors will opt for these investments and investment in bonds will come down. To resolve the issue, city should:
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