Basic bond valuation Complex Systems has an outstanding issue of 1,000-par-value

Question

Basic bond valuation Complex Systems has an outstanding issue of 1,000-par-value bonds with a12% coupon interest rate. The issue pays interest annually and has 14 years remaining to its maturity date.

a.If bonds of similar risk are currently earning a rate of return of 8%, how much should the Complex Systems bond sell for today?

b.Describe the two possible reasons why the rate on similar-risk bonds is below the coupon interest rate on the Complex Systems bond.

c.If the required return were at 12% instead of 8%, what would be the current value of Complex Systems' bond? Contrast this finding with your findings in part a and discuss.

Explanation / Answer

a) Bond Price can be calculated using PV function

N = 14, PMT = 12% x 1000 = 120, FV = 1000, I/Y = 8% => Compute PV = $1,329.77

b) One reason could be they are issued at a later stage when the interest rates have reduced. Secondly, they could have a different duration, i.e. time to maturity than Complex bonds.

c) If I/Y = 12% then PV = $1,000

As the rates had risen from 8% to 12%, the bond price have declined from 1,329.77 to 1,000.

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