For example, assume Grace wants to earn a return of 14.00% and is offered the op

Question

For example, assume Grace wants to earn a return of 14.00% and is offered the opportunity to purchase a $1,000 par value bond that pays a 12.00% coupon rate (distributed semiannually) with three years remaining to maturity. The following formula can be used to compute the bond's intrinsic $240.00 $60.00 90.00 Semiannual required return Complete the following table by identitying the appropriate corresponding variables used in the equation Variable Value $1,000 Bond's annual coupon payment Bond's market $1,000 and the data, it is Based on this greater than $1,000. to expect that Grace's potential bond investment is currently exhibiting an intrinsic value Bond's par value Now, consider the situation in which Grace wants to earn a return of 15%., but the bond being considered for purchase offerscoupon rate of 12.00%. Again, assume that the bond pays semiannual interest payments and has three years to maturity. you round the bond's intrinsic value to the nearest whole dolar, then its intrinsic value of (rounded to the nearest whole dolar) is ts par value, so that the Semiannual required return Given your computation and conclusions, which of the following statements is true? When the coupon rate is greater than Grace's required retum, the bond's intrinsic value will be less than its par value. When the coupon rate is greater than Grace's required return, the bond shouid trade at a discount. A bond should trade at a par when the coupon rate is greater than Grace's required return When the coupon rate is greater than Grace's required return, the bond should trade at a premium 65000% 7.0000% 7525% he data, t is to expect that Graces potential

Explanation / Answer

As per rules I will answer the first 4 sub parts of the question

1:A= Bond semi-annual coupon payment = 12%*1000/2 = $60

2: B= Bond’s par value = $1000

3: C= Semiannual required return = 14%/2 = 7%

4: Incorrect/ Unreasonable

Intrinsic value = 60/1.07^1 + 60/1.07^2 + 60/1.07^3+ 60/1.07^4 + 60/1.07^5 + 60/1.07^6+ 1000/1.07^6

= $952.33

So it is INCORRECT to expect that the current intrinsic value is showing an amount >$1000

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