Intrinsic Value = A/(1-C)^1 +A/(1+C)^2 + A/(1+C)^3 + A/(1+C)^4 + A/(1+C)^5 + B/(

ID: 2640679 • Letter: I

Question

Intrinsic Value = A/(1-C)^1 +A/(1+C)^2 + A/(1+C)^3 + A/(1+C)^4 + A/(1+C)^5 + B/(1+C)^6 Complete the following table by identifying the appropriate corresponding variables used in the equation. Unknown Variable Name Variable Value Based on this equation and the data, it is reasonable to expect that Ethan?s potential bond investment is currently exhibiting an intrinsic value equal to $1,000. Now, consider the situation in which Ethan wants to earn a return of 3.00%, but the bond being considered for purchase offers a coupon rate of 5.00%. Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the bond?s intrinsic value to the nearest whole dollar, then its intrinsic value of is its par value, so that the bond is trading at a premium Given your computation and conclusions, which of the following statements is true? When the coupon rate is greater than Ethan's required return, the bond should trade at a discount. A bond should trade at a par when the coupon rate is greater than Ethan?s required return. When the coupon rate is greater than Ethan's required return, the bond?s intrinsic value will be less than its par value. When the coupon rate is greater than Ethan's required return, the bond should trade at a premium.

Explanation / Answer

Hi,

Please find the detailed answer as follows;

Step 1: Intrinsic Value of the Bond:

Nper = 3*2 = 6 (indicates the period)

PV = ? (indicates the intrinsic value)

FV = 1000 (indicates the face value)

Rate = 3%/2 (indicates semi-annual YTM)

PMT = 1000*5%*1/2 = 25 (indicates the amount of interest payment)

Intrinsic Value = PV(Rate,Nper,PMT,FV) = PV(3%/2,6,25,1000) = $1056.97 or $1057

If you round the bond' s intrinsic value to the nearest whole dollar, then its intrinsic value of $1057 is greater than its par value, so that the bond is trading at a premium.

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Part B:

Option D (when the coupon rate is greater than the required return, the bond should trade at a premium) is the correct answer.

Thanks.

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