Question

ReNew Corporation raises funds to build renewable energy systems by issuing 3-year bonds with a coupon rate of 6% and a face value of $1,600. Assume that the market interest rate for a 3-year bond issued by a firm like ReNew is currently the same as the coupon rate. The price of each of these bonds is____ , which means that the bonds sell at ___. Suppose that the market interest rate for bonds that are similar to the ReNew bond has increased to 7%. The price of the ReNew bond changes to____ , which means that it sells at ____. Suppose that instead of rising, the market rate decreases from 6% to 4%. The new price of the bond changes to ___, which means that the bond sells at ___.

Answer 1

The price of each of these bonds is $1,600, which means that the bonds sell at par.

Suppose that the market interest rate for bonds that are similar to the ReNew bond has increased to 7%. The price of the ReNew bond changes to $1,558.00 , which means that it sells at discount.

Suppose that instead of rising, the market rate decreases from 6% to 4%. The new price of the bond changes to $1,688.80, which means that the bond sells at a premium.

When the coupon rate and the market interest rate are the same, the price will be at par.

Interest rate increases:

Bond Price = Present value of coupon + Present value of bond price

Coupon = 6% * 1,600

= $96

Bond price = 96 * (1 - 1.07⁻³ / 0.07) + 1,600 / 1.07³

Bond price = $1,558.00

Interest rate decreases:

= 96 * (1 - 1.04⁻³ / 0.04) + 1,600 / 1.04³

= $1,688.80