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Unformatted text preview: pay interest semiannually (every 6
months) at a stated coupon interest rate, have an initial maturity of 10 to
30 years, and have a par value, or face value, of $1,000 that must be repaid at
Mills Company, a large defense contractor, on January 1, 2004, issued a 10%
coupon interest rate, 10-year bond with a $1,000 par value that pays interest
semiannually. Investors who buy this bond receive the contractual right to two
cash flows: (1) $100 annual interest (10% coupon interest rate
value) distributed as $50 (1/2 $100) at the end of each 6 months, and (2) the
$1,000 par value at the end of the tenth year.
We will use data for Mills’s bond issue to look at basic bond valuation. Basic Bond Valuation
The value of a bond is the present value of the payments its issuer is contractually
obligated to make, from the current time until it matures. The basic model for the
value, B0, of a bond is given by Equation 6.7:
n B0 I
t I 1 (1 1
kd)t (PVIFAk d ,n ) M
(6.7a) 11. Bonds often have features that allow them to be retired by the issuer prior to maturity; these conversion and call
features were presented earlier in this chapter. For the purpose of the current discussion, these features are ignored. CHAPTER 6 Interest Rates and Bond Valuation 285 where
kd value of the bond at time zero
annual interest paid in dollars12
number of years to maturity
par value in dollars
required return on a bond We can calculate bond value using Equation 6.7a and the appropriate financial
tables (A–2 and A–4) or by using a financial calculator.
EXAMPLE Assuming that interest on the Mills Company bond issue is paid annually and
that the required return is equal to the bond’s coupon interest rate, I $100, kd
10%, M $1,000, and n 10 years.
The computations involved in finding the bond value are depicted graphically on the following time line.
End of Year Time line for bond
coupon interest rate,
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