The Morgan Corporation has two different bonds currently outstanding. Bond M has

Question

The Morgan Corporation has two different bonds currently outstanding. Bond M has a face value of $17,500 and matures in 24 years. The bond makes no payments for the first 5 years, then pays $1,100 every six months over the subsequent 14 years, and finally pays $1,400 every six months over the last 5 years. Bond N also has a face value of $17,500 and a maturity of 24 years; it makes no coupon payments over the life of the bond. If the required return on both these bonds is 12 percent compounded semiannually, the current price of Bonds M and N is $ and $ , respectively.

Explanation / Answer

Valuing Bonds – The Morgan Corporation has two different bonds currently outstanding. Bond M has a face value of $20,000 and matures in 20 years. The bond makes no payments for the first six years, then pays $800 every six months over the subsequent eight years, and finally pays $1,000 every six months over the last six years. Bond N also has a face value of $20,000 and a maturity of 20 year; it makes no coupon payments over the life of the bond. If the required return on both these bond is 8 percent compounded semiannually, what is the current price of Bond M? Of Bond N? The price of any bond ( or financial instrument) is the PV of the future cash flows. Even though bond M makes different coupons payments, to find the price of the bond, we just find the PV of the cash flows. The PV of the cash flows for bond M is: PM = $800(PVIFA4%,16)(PVIF4%,12) + $1000(PVIFA4%,12)(PVIF4%,28) + $20,000 (PVIF4%,40) PM = $ 13,117.88 Notice that for the coupon payments of $800, we found the PVA for the coupon payments, and then discounted the lump sum back today. Bond N is a zero coupon bond with a $20,000 par value; therefore, the price of the bond is the PV of the par, or: PN = $20,000 (PVIF4%,40) = $4,165.78

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