10.(Bond valuation) Kyser Public Utilities issued a bond with a $1,000 par value

Question

10.(Bond valuation) Kyser Public Utilities issued a bond with a $1,000 par value that pays $90 in annual interest. It matures in 15 years. Your required rate of return is 7 percent.

a. Calculate the value of the bond.

b. How does the value change if your required rate of return (1) increases to 11 percent or (2) decreases to 6percent?

c. Explain the implications of your answers in part (b) as they relate to interest rate risk, premium bonds, and discount bonds.

d. Assume that the bond matures in 5 years instead of 15 years. Recompute your answers in part (b).

e. Explain the implications of your answers in part (d) as they relate to interest rate risk, premium bonds, and discount bonds.

Explanation / Answer

Par Value 1000 Coupon 90 Time 15 years Rate of Return 7% a Value of the bond= 1000*(Present value factor(7%, 15 years)+ 90 *(Annuity factor(7%, 15years) 1000*0.3624 + 90*9.108 819.71 b (1) If rate of return changes to 11% Value of the bond= 1000*(Present value factor(11%, 15 years)+ 90 *(Annuity factor(11%, 15years) 209+ 647.18 856.18 b(2) If rate of return changes to 6% Value of the bond= 1000*(Present value factor(6%, 15 years)+ 90 *(Annuity factor(6%, 15years) 417.27+874.10 1291.37 c The Present value increases with the fall in interest rate and decreases with an increase in interest rate due to interest rate premium d(1) If rate of return changes to 11% and the period is 5 years Value of the bond= 1000*(Present value factor(11%, 5 years)+ 90 *(Annuity factor(11%, 5years) 926.08 d(2) If rate of return changes to 6% and the period is 5 years Value of the bond= 1000*(Present value factor(6%, 5 years)+ 90 *(Annuity factor(6%, 5years) 1130.11 e The implications are due to time factor. The time period within which the amount is repaid plays an important part in the present value

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