When the market rate of interest was 12%, Patel Corporation issued $1,000,000, 1

Question

When the market rate of interest was 12%, Patel Corporation issued $1,000,000, 11%, 10-year bonds that pay interest annually. The selling price of this bond issue was

a. $ 321,970

b. $1,000,000

c. $ 943,494

d. $621,524

This is my third time posting this question and I am not clear of how each person came up with market rate of interest from the 12%. I understand how they came up with 110,000 (1,000,000* 11%), but I do not understand how to come up with the 5.650. Please help me understand this calculation. I am getting so frustated.

Explanation / Answer

Selling price of bond = Present value of Interest payments + Present value of face value to be redeemed on maturity

Market return is 12%.It means that the investments in market are paying on an average 12% interest and hence, the interest and face value shall be discounted by this rate to get the selling price of bond.

Annual interest payment = $1,000,000 * 0.11 = $110,000

Present value of annuity of $110,000 = $110,000 * ( 1 - 1.12-10)/0.12 = $110,000 * 5.6502 = $621,524

Present value of redemption value = $1,000,000 / 1.1210 = $321,970

Selling price of bond issue = $621,524 + $321,970 = $943,494

Hope this will solve your confusion.

Here i would like to explain you further that the bond is paying 11% interest whereas other investments are giving 12% interest. Due to this, investors will not pay the face value of bonds and would like to buy the bonds only if they get some discount. Hence, bonds of $1,000,000 will sell at discount for $943,494.

If the market return is less than the bond rate then the bond shall sell at premium.

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.