STOCKS & BONDS

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Two years ago, Gamma Inc. sold a $250 million bond issue to finance the purchase of new jet airliners. These bonds were issued in $1,000 denominations with an original maturity of 14 years and a coupon rate of 12% with interest paid semiannually. Determine the value today of one of these bonds to an investor who requires a 14 percent return on these securities. Explain why the bond has a value that is not equal to the par value.

  • STOCKS & BONDS -

    Face value = $1,000
    Coupon rate = 12%
    Frequency of coupon payment = Semiannual
    Coupon payment = $1,000*12%*1/2 = $60
    Time to maturity now = 14 – 2 = 12 years
    Required rate of return = 14%
    Value of bond today = $60*PVIFA14%/2, 12*2 + $1,000*PVIF14%/2, 12*2
    = $60*PVIFA7%, 24 + $1,000*PVIF7%, 24
    = $60*11.46933 + $1,000*0.19715
    = $688.16 + 197.15
    = $885.31
    Since Coupon rate ≠ Required rate of return, bond value is not equal to par value.
    Coupon rate < Required rate of return, Bond value < Par value

  • STOCKS & BONDS -

    Face value = $1,000
    Coupon rate = 12%
    Frequency of coupon payment = Semiannual
    Coupon payment = $1,000*12%*1/2 = $60
    Time to maturity now = 14 – 2 = 12 years
    Required rate of return = 14%
    Value of bond today = $60*PVIFA14%/2, 12*2 + $1,000*PVIF14%/2, 12*2
    = $60*PVIFA7%, 24 + $1,000*PVIF7%, 24
    = $60*11.46933 + $1,000*0.19715
    = $688.16 + 197.15
    = $885.31
    Since Coupon rate ≠ Required rate of return, bond value is not equal to par value.
    Coupon rate < Required rate of return, Bond value < Par value

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