Question

A 10-year annual payment corporate bond has a market price of $1,050. It pays annual interest of $100 and its required rate of return is 9 percent. By how much is the bond mispriced?

a)Overpriced by $14.18
b)Underpriced by $9.32
c)Overpriced by $9.32
d)Underpriced

Answer 1

The bond is underpriced by $9.32.

Step-by-step explanation:

The bond is underpriced by $9.32.

To calculate the mispricing of the bond, we first need to calculate the present value of the bond's cash flows. The bond pays an annual interest of $100 for 10 years, and at the end of the 10 years, it repays the face value of $1,000.

Using the required rate of return of 9%, we can calculate the present value of the bond as follows:

1. Calculate the present value of the annual interest payments:

1. Calculate the present value of the bond's face value:

1. Sum up the present values of the interest payments and the face value:

1. Compare the calculated present value with the market price to determine the bond's mispricing:

The result is that the bond is underpriced by $9.32.