A 10-year bond with a 5% coupon and a 1million VND par value is currently priced at
821,000VND.
a. If the current market interest rate is 8%. Should you buy the bond? Why or why not?
b. Assuming you buy and hold this bond for 6 years. What price must you sell the bond for if you
want to earn a 9% rate of return on this investment?
a. To determine whether you should buy the bond when the current market interest rate is 8%, we need to compare the yield of the bond (coupon rate) with the market interest rate.
To calculate the yield of the bond, we can use the formula:
Yield = (Coupon Payment / Bond Price) * 100
The Coupon Payment is the annual interest payment, which can be calculated as:
Coupon Payment = Coupon Rate * Par Value
Substituting the given values, we have:
Coupon Payment = 5% * 1,000,000 VND = 50,000 VND
The Yield is then:
Yield = (50,000 VND / 821,000 VND) * 100 = 6.09%
Comparing the yield (6.09%) with the market interest rate (8%), we can see that the market interest rate is higher than the yield of the bond. Since the bond's yield is lower than the market interest rate, it implies that the bond is not attractively priced and does not offer a competitive return. Therefore, you should not buy the bond.
b. To calculate the selling price of the bond after 6 years, we need to consider the bond's coupon payments and the desired rate of return.
The coupon payment will remain the same throughout the holding period, which is 50,000 VND per year.
The desired rate of return is 9%, which we can convert into a decimal by dividing it by 100: 9% / 100 = 0.09.
Using the formula for the present value of an annuity, we can calculate the present value of the future cash flows generated by the bond over 6 years:
Present Value = (Coupon Payment / (1 + Desired Rate)^Time) + (Coupon Payment / (1 + Desired Rate)^(Time - 1)) + ... + (Coupon Payment / (1 + Desired Rate)^1) + (Coupon Payment + Par Value / (1 + Desired Rate)^Time)
Substituting the values, we have:
Present Value = (50,000 VND / (1 + 0.09)^1) + (50,000 VND / (1 + 0.09)^2) + ... + (50,000 VND / (1 + 0.09)^6) + (50,000 VND + 1,000,000 VND / (1 + 0.09)^6)
Simplifying this equation will give us the present value of the bond after 6 years. Let's assume it is X VND.
To find the selling price of the bond, we need to solve for X in the following equation:
X = 821,000 VND * (1 + 0.09)
Solving for X, we have:
X = 821,000 VND * (1.09) = 895,890 VND
Therefore, in order to earn a 9% rate of return on this investment, you must sell the bond for a price of approximately 895,890 VND after holding it for 6 years.
trr
A 10-year bond with a 5% coupon and a 1 million VND par value is currently priced at
821,000VND.