Question
What would you pay for a $110,000 debenture bond that matures in 15 years and pays $5,500 a year in interest if you wanted to earn a yield of 8%:
Answer:
Price of bond = $ 81,753.72
Explanation:
The value of the bond is the present value(PV) of the future cash receipts expected from the bond. The value is equal to present values of interest payment plus the redemption value (RV).
Value of Bond = PV of interest + PV of RV
The price of the bond can be worked out as follows:
Step 1
PV of interest payments
annul interest payment = $5,500
Annual yield = 8%
Total period to maturity (in years) = 15
PV of interest =
5500 × (1- (1+0.08)^(-15)/)/0.08 = 47,077.13
Step 2
PV of Redemption Value
= 110,000 × (1.08)^(-15) = 34,676.59
Price of bond
47,077.13 + 34,676.59
=$ 81,753.72
Price of bond = $ 81,753.72
