Bond valuation is an important aspect of investment strategies for fixed income securities. To value a security, we discount its expected cash flows by appropriate discount rate.
Suppose Jagdambay manufacturing sells a bond paying a coupon rate of 5% per year with par value (face value) of $200,000 when the market rate is only 4% per year. The bond has 5 years until maturity.
a. Based on the above information, please calculate bond’s price today.
VB = C1 / (1+r)1 + C2 / (1+r)2 + … + C5 / (1+r)N + P / (1+r)N
VB = Value of bond
C = Coupon payment (Par value x Coupon rate)
r = Discount rate (The bond’s required rate of return)
N = Number of years before the bond matures
P = Par value of the bond
b. What is the bond’s price today if market rate is 6%?
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