Question

Your opportunity cost of funds used for investing is 8.5%. What is the most you would pay for a bond that has a coupon rate of 10.0% and matures in 20 years?

(A) $1,143.0796
(B) $1,099.7077
(C) $871.3069

Answer 1

The maximum price you would pay for the bond is $1,143.0796. Hence, the correct answer is option (A).

Step-by-step explanation:

When the market interest rate is higher than the coupon rate on a bond, the bond will sell at a discount. In this case, the bond has a coupon rate of 10.0% and the market interest rate is 8.5%. To determine the maximum price you would pay for the bond, you can calculate the present value of the bond's future cash flows. The formula to calculate the present value of a bond is:

PV = C/(1+r)t + C/(1+r)t-1 + ... + C/(1+r) + M/(1+r)t

Where PV is the present value, C is the coupon payment, r is the interest rate, t is the number of periods, and M is the face value of the bond. Plugging in the values for the bond with a coupon rate of 10.0% and a maturity of 20 years, the maximum price you would pay for the bond is $1,143.0796.