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Estimating fair value of a bond

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1. Find the value of a bond with the following characteristics: (a) face value of $1,000, (b) 8% coupon rate, (c) the bond matures in 14 years, (d) the market rate of interest is 6%.

2. Is the bond priced in question 1 selling at a discount or premium to its par value?

3. Using the information from question 1: the market rate of interest has risen to 10% and one year passed. How much would you be willing to pay for the bond now?

4. Using the information from question 1, determine whether the bond is selling at a premium, discount, or par value.

5. Using the information from question 1, another year goes by and the market rate of interest drops down to 8%. Is the bond currently selling at discount to par, premium to par, or at par value.

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Solution describes the steps to estimate the fair value of bond in the given scenarios.

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1. Find the value of a bond with the following characteristics: (a) face value of $1,000, (b) 8% coupon rate, (c) the bond matures in 14 years, (d) the market rate of interest is 6%.

C=Coupon = 1000*8%=$80
r= required rate of return = 6%
n= time to maturity for bond = 14 years
P= Par value of bond = $1000

Value of bond= C/r*(1-1/(1+r)^n)+P/(1+r)^n
=80/6%*(1-1/(1+6%)^14)+1000/(1+6%)^14
=$1185.90
2. Is the ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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