Final answer:
The cash flows for the bond in question consist of $2,500 semi-annual interest payments for 10 years plus the $100,000 face value at maturity. An example with a two-year bond shows how these payments would look, and how rising interest rates decrease the present value of future cash flows.
Step-by-step explanation:
The student has asked to calculate the cash flows an investor will receive from a bond issued by Krystian Inc. This bond has a face value of $100,000, a stated interest rate of 5%, and a market rate at issuance of 6%. The bond has a 10-year maturity and interest is paid semi-annually.
The cash flow to the investor, in this case, consists of semi-annual interest payments and the repayment of the principal at maturity. Since the stated rate is 5%, the annual interest payment is:
$100,000 × 5% = $5,000 per year
The semi-annual interest payment will be half of that, so:
$5,000 / 2 = $2,500 every six months
These interest payments will be made for 10 years, or 20 semi-annual periods. At the end of the 10th year, the investor will also receive the face value of the bond, which is $100,000. Therefore, the total cash flows would consist of $2,500 paid every six months for 20 periods, plus the $100,000 at the end of the term.
As an example to reinforce this concept:
- For a simple two-year bond with an 8% interest rate and a $3,000 face value, the cash flow would be $240 at the end of the first year, and $240 plus the principal of $3,000 at the end of the second year.
The present value of these cash flows would vary depending on the discount rate. If the discount rate is the same as the interest rate (8% in the example), then the present value would equal the face value of the bond. If interest rates rise and the discount rate exceeds the coupon rate (11% in the example), the present value of the bond would be less than the face value because the future cash flows would be discounted at a higher rate, making them less valuable in present terms.