The present value of a coupon bond Aa Aa eneral Finance Ltd. (GFL) issues a coup

Question

The present value of a coupon bond Aa Aa eneral Finance Ltd. (GFL) issues a coupon bond that makes an interest payment (F) of $100 each year for five years and then repays the face value (V) of $1,000 at the end of that time. Suppose the interest rate (i) is 2%. Which of the following formulas do investors need to use to determine the present value of P = coupon bond? of this O A single payment of the face value at maturity O The sum of fixed payments and a single payment of the face value at maturity O The sum of fixed payments Next, suppose that General Finance Ltd. (GFL) issues 10-year bonds in 2011 with face values of $1,000 and $50 coupons The interest rate at which GFL issues these bonds is When the bond reaches maturity In 2021, how much will each investor holding one of these GFL bonds receive? O The initial investment of $1,000 plus $50 for the 10th coupon $500 worth of coupons ($50 per year x 10 years) O The initial investment of $1,000 plus $500 worth of coupons ($50 per year x 10 years) Suppose interest rates fall dramatically. The market price of these GFL bonds will

Explanation / Answer

Present value of a coupon bond is calculated as follows -

PV = PV of coupon payments + PV of face value to be received at maturity

So,

In given case,

The present value, P, is equal to the sum of the fixed payments and a single payment of the face value at maturity.

Hence, the correct answer is the option (2) [the sum of the fixed payments and a single payment of the face value at maturity].

Face value of bond = $1,000

Coupon payment = $50

Calculate the interest rate -

Interest rate = (Coupon payment/Face value) * 100 = ($50/$1,000) * 100 = 5%

Thus,

The interest rate at which GFL issues these bonds is 5 percent.

At maturity in 2021, each investor will receive the intial investment of $1,000 plus $50 for the 10th coupon.

Hence, the correct answer is the opiton (1) [the intial investment of $1,000 plus $50 for the 10th coupon].

Price of bond and interest rate moves in the opposite directions.

So,

Suppose interest rates fall dramatically, the market price of these GFL bonds will rise.

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