BioMax Inc. offers an 8 percent coupon bond that has a $1,000 par value, semiann
ID: 2632430 • Letter: B
Question
BioMax Inc. offers an 8 percent coupon bond that has a $1,000 par value, semiannual coupon payments and 20 years of its original 25 years left to maturity. Which of the following statements is true if the market return on similar bonds is 10%? a. The bond will sell at a premium of $1,198 because the coupon rate is less than the market interest rate. b. The bond will sell at a discount of $828 because the coupon rate is greater than the market interest rate. c. The bond will sell at a discount of $817 because the coupon rate is less than market interest rate. d. The bond will sell at a discount of $828 because the coupon rate is less than the market interest rate.
Explanation / Answer
Current Yield is something totally different from YTM or Yield to Maturity
Interest Payment = Par Value x Coupon Rate
Interest Payment = $1000 x 0.08
Current Yield = Interest Payment / Market Price
8.21% = 80 / Market Price
Market Price = 80 / 8.21%
Market Price = 80 / 0.0821
Market Price = $974.42
Let's now find the YTM or Yield Till Maturity
Here we do it with MS Excel RATE function
=RATE(nper,pmt,pv,fv,type,guess)
nper = 2 x 5 = 10
pmt = 1000 x 8%/2 = 1000 x 4% = 40
pv = -974.42
fv = 1000
type = 0 for end of period payments
=RATE(10,40,-974.42,1000,0)
4.32%
We can try to check if Bond's Market price is in fact $974.42 with a YTM of 4.32%
In MS Excel
=PV(0.0432,10,40,1000)
($974.45)
Numeric Solution to find bond's Market Price
P0 = INT x PVIFA(i,n) + TV x PVIF(i,n)
P0 is the Market Value of the debt or bond
INT is the amount of periodic interest payment at coupon rate $1000x0.04 = $40
PVIFA(i,n) is the Present Value Interest Factor of ordinary annuity of
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