hinsafdar

A corporate bond with the following data is issued:

• $1,000 par value.
• 8% coupon payments.
• 5 years to maturity with semiannual coupon payments.
• Market interest rates are 10%.

What is the total interest expense?

A) 923.

B) 545.

C) 477.

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Total interest expense is the difference between the amount paid by the issuer and the amount received from the bondholder.
Present value of the bond is computed as follows: FV = 1,000; PMT = [(1,000)(0.08)] / 2 = 40; I/Y = 5; N = 10; CPT → PV = -923
[($40 coupon payments)(10 periods) + $1,000 par value] – $923 present value of the bond = 477

hinsafdar

Assume a city issues a $5 million bond to build a new arena. The bond pays 8% semiannual interest and will mature in 10 years. Current interest rates are 9%. What is the present value of this bond and what will the bond's value be in seven years from today?

Present Value

Value in 7 Years from Today

A) 4,674,802 4,871,053

B) 4,674,802 4,931,276

C) 5,339,758 4,871,053

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Present Value:
Since the current interest rate is above the coupon rate the bond will be issued at a discount. FV = $5,000,000; N = 20; PMT = (0.04)(5 million) = $200,000; I/Y = 4.5; CPT → PV = -$4,674,802
Value in 7 Years:
Since the current interest rate is above the coupon rate the bond will be issued at a discount. FV = $5,000,000; N = 6; PMT = (0.04)(5 million) = $200,000; I/Y = 4.5; CPT → PV = -$4,871,053

hinsafdar

Answering an essay question on a midterm examination, a finance student writes these two statements:
Statement 1: The value of a fixed income security is the sum of the present values of all its expected future coupon payments.
Statement 2: The steps in the bond valuation process are to estimate the bond’s cash flows, determine the appropriate discount rate, and calculate the present value of the expected cash flows.
With respect to the student's statements:

A) only one is correct.

B) both are correct.

C) both are incorrect.

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Statement 1 is incorrect. The value of a fixed income security is the sum of the present values of its expected future coupon payments and its future principal repayment. Statement 2 is correct. The three steps in the bond valuation process are to estimate the cash flows over the life of the security; determine the appropriate discount rate based on the risk of the cash flows; and calculate the present value of the cash flows using the appropriate discount rate.