Quinn Electric Company has outstanding a bond issue that will mature to its $1,000 par value in 12 years. The bond has a coupon rate of 15% and pays the interest annually.
a) Find the value of the bond if the required return is (1) 10 percent, (2) 15 percent and (3) 17 percent.
b) Use your findings in part a) to discuss the relationship between coupon interest rate on a bond and the required return and the market value of the bond relative to its par value.
c) What two reasons cause the required return to differ from the coupon interest rate?
The value of the bond is found by discounting the cash flows and then adding them up. In the given case, the bond has a maturity of 10 years. The cash flows from the bond are 10 interest payments and 1 principal repayment. The interest payments are in the nature of annuity and we will use the PVIFA table to get the Present Value and for Principal Repayment we will use the PVIF table. The interest amount is 1000 X 15%=150 and the principal amount is ...
The solution explains how to calculate the bond prices given the required rate of return. It also discusses the relationship between required return and market value of bond. This solution is 340 words.