The Altoona Co. issued a 25-year bond 5 years agowith a face value of
QUESTION
The Altoona Co. issued a 25-year bond 5 years agowith a face value of $1,000. The bond pays interest semiannually at a 10% annual rate.a. What is the bonds price today if the interest rate on comparable new issues is 12%?b. What is the price today if the interest rate is 8%?c. What is the price tod
PB = PMT [PVFAk,n] FV [PVFk,n] a. n = 20 2 = 40 k = 12/2 = 6 PMT = $1,000 .10/2 = $50 PB = $50 [PVFA6,40] $1,000 [PVF6,40] = $50 (15.0463) $1,000 (.0972) = $849.52 b. k = 8/2 = 4 PB = $50 [PVFA4,40] $1,000 [PVF4,40] = $50 (19.7928) $1,000 (.2083) = $1,197.94 In part a the interest rate has risen above the coupon rate. Therefore an investment equal to the bonds face value would earn more if placed in newly issued bonds. That means the bonds price has to
ease below face value to keep its yield competitive with new issues. In part b the bond offers more than new issues costing $1,000. Therefore, its price can increase above $1,000 and still remain competitive. c. $1,000. d. A bond will always sell at par value when the interest rate is equal to its coupon rate.
ANSWER:
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