Question

Several years ago MMM Company borrowed money through a bond issue with the following features. Each individual bond has a $1,000 par value and a 9% annual coupon interest rate, with interest paid semi-annually (twice per year), and will mature five years from today.

What price should someone who requires an 8% annual rate of return (yield to maturity) be willing to pay for one of these bonds?

Answer 1

$1040.56

Step-by-step explanation:

A bond is debt instrument issued by a borrower which promises to pay the holder regular interest for the holding period and the terminal value at the end of the period.

According to the discounted cash flow model, the value of an asset is the present value of the future cash flows arising from the assets discounted at the required rate of return.

Present value is the worth today of an amount expected in the future.The process of calculating the present value is called discounting

To calculate the price of this bond, we shall discount the future cash flows using the required return of 8% per annum, which is the same as 4% per six-month

Interest payment per 6 month = (9% × $1000)/2= $45

PV of interest payment = 45 × (1- (1.04)^(-2×5))/0.04)= 364.995

PV of redemption value = 1000 × 1.04^(-2× 5) = 675.56

Price of the bond 1040.56