292 part 2 important financial concepts i 2 example

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Unformatted text preview: e are equal; for B0 to equal M, as would be expected in such a case, the maturity value must be discounted on a semiannual basis. 292 PART 2 Important Financial Concepts I 2 EXAMPLE (PVIFAkd/2,2n) M (PVIFkd/2,2n) (6.8a) Assuming that the Mills Company bond pays interest semiannually and that the required stated annual return, kd, is 12% for similar-risk bonds that also pay semiannual interest, substituting these values into Equation 6.8a yields B0 $100 2 (PVIFA12%/2,2 10yrs) $1,000 (PVIF12%/2,2 10yrs) Table Use B0 Input 20 Function N 6 I 50 PMT 1000 FV CPT PV Solution 885.30 $50 (PVIFA6%,20periods) $1,000 (PVIF6%,20periods) $50 (11.470) (0.312) $885.50 $1,000 Calculator Use In using a calculator to find bond value when interest is paid semiannually, we must double the number of periods and divide both the required stated annual return and the annual interest by 2. For the Mills Company bond, we would use 20 periods (2 10 years), a required return of 6% (12% 2), and an interest payment of $50 ($100 2). Using these inputs, you should find the bond value with semiannual interest to be $885.30, as shown at the left. Note that this value is more precise than the value calculated using the rounded financial-table factors. Comparing this result with the $887.00 value found earlier for annual compounding (see Table 6.6), we can see that the bond’s value is lower when semiannual interest is paid. This will always occur when the bond sells at a discount. For bonds selling at a premium, the opposite will occur: The value with semiannual interest will be greater than with annual interest. Review Questions 6–16 What basic procedure is used to value a bond that pays annual interest? Semiannual interest? 6–17 What relationship between the required return and the coupon interest rate will cause a bond to sell at a discount? At a premium? At its par value? 6–18 If the required return on a bond differs from its coupon interest rate, describe the behavior of the bond value over time as the bond moves toward...
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This document was uploaded on 01/19/2014.

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