Question

You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.

Answer 1

The answer is: Yes, you should buy this bond.

Step-by-step explanation:

In order to buy the bond, you are going to invest $800

Each year, during 9 consecutive years, you will earn $100 in interest.

At the end of year 10, you will receive $1,000.

To find out if this bond is a good investment, you must calculate its net present value (NPV) using this formula: NPV = ∑(P/ (1+i)t ) – C, were:

• P = periodic cash flows (100, 100, 100, 100, 100, 100, 100, 100, 100, 1000)
• i = discount rate = 12%
• t = number of time periods = 10
• C = capital = 800

The NPV of this investment is $54.80, that means it is good investment for you. Any investment with a NPV ≥ 0 is considered a good investment.