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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
maturity.11
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
$1,000 par
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
M 1
kd)n (1
(PVIFk )
d,n (6.7)
(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
B0
I
n
M
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
valuation (Mills
Company’s 10%
coupon interest rate,
10-year maturity,
$1,000 p...

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