Jim Busby calls his broker to inquire about purchasing a bond of Disk Storage Sy

Question

Jim Busby calls his broker to inquire about purchasing a bond of Disk Storage Systems. His broker quotes a price of $1,150. Jim is concerned that the bond might be overpriced based on the facts involved. The $1,000 par value bond pays 13 percent interest, and it has 16 years remaining until maturity. The current yield to maturity on similar bonds is 11 percent. a. Calculate the present value of the bond. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods

Explanation / Answer

Yes, Bond is overpriced.

a. Present value of the bond $    1,148 Present value of the bond is the present value of cash flow from bond. There are two cash flow from bond -a) Coupon Interest and b) Maturity Value Present value of coupon interest $       959 Present value of Par Value $        188 Present value of bond $    1,148 Working: a. Coupon interest = Par Value x Coupon Rate = $    1,000 x 13% = $        130 b. Maturity Value = Par Value = $    1,000 c. Cumulative discount factor = (1-(1+i)^-n)/i Where, = (1-(1+0.11)^-16)/0.11 i = 11% =      7.3792 n = 16 d. Discount factor for 16 years = 1.11^-16 =      0.1883 e. Present value of coupon interest = $        130 x      7.3792 = $        959 f. Present Value of Par Value = $    1,000 x      0.1883 = $        188

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