For example, assume Ella wants to earn a return of 9.00% and is offered the opportunity to
purchase a $1,000 par value bond that pays a 7.50% coupon rate (distributed semiannually) with
three years remaining to maturity. The following formula can be used to compute the bond's
intrinsic value: Intrinsic Value =A/(1 + C)^1+/A(1 + C)^2 +/A(1 + C)^3+A/(1 +
C)^4+A/(1+CJ^5+A/(1 + C)^6+B/(1 + C)^6 Complete the following table by identifying the
appropriate corresponding variables used in the equation. Based on this equation and the data, it
is unreasonable to expect that Ella's potential bond investment is currently exhibiting an intrinsic
value less than $1,000. Now, consider the situation in which Ella wants to earn a return of
4.50%, but the bond being considered for purchase offers a coupon rate of 7.50%. Again, assume
that the bond pays semiannual interest payments and has three years to maturity. If you round the
bond's intrinsic value to the nearest whole dollar, then its intrinsic value of is its par value, so
that the bond is Given your computation and conclusions, which of the following statements is
true? A bond should trade at a par when the coupon rate is greater than Ella's required return.
When the coupon rate is greater than Ella's required return, the bond should trade at a premium.
When the coupon rote is greater thon Clio's required return, the bond should t:"ode ot o
discount. When the coupon rate is greater than Ella's required return, the bond's intrinsic value
will be less than its par value.
Solution
Eila's required return 9% Bond coupon rate 7.50% Semi annula required return =
4.50% As the coupon rate is lower than the required rate return ; Based on this equation
and the data, it is --Reasonable -- to expect that Eila's potential Bond invetsment is
currently exhibiting a n intrinsic value less than $1000 When Eila's required return=
4.50% Bond coupon rate 7.50% Years of maturity 3.00 Semi annual
coupon rate 3.75% Par value 1,000.00 Semi annual discount rate 2.25%
Bond Price calculation Period Interest+Maturity Discount factor @2.25% PV of cash flow
1.00 37.50 0.98 36.67
2.00 37.50 0.96 35.87
3.00 37.50 0.94 35.08
4.00 37.50 0.91 34.31
5.00 37.50 0.89 33.55
6.00 1,037.50 0.88 907.84
1,083.32 So current bond price is $1,083.32 Ans it is trading at premium . The correct
statement is ; When the coupon rate is greater than Eila's required return, the bond should
trade at premium.