# 11 mills company a large defense contractor on

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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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## This document was uploaded on 01/19/2014.

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