Her research indicates that she must earn 10 on low

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Unformatted text preview: average-risk assets, and 22% on high-risk assets. a. Determine what is the most Laura should pay for the asset if it is classified as (1) low-risk, (2) average-risk, and (3) high-risk. b. Say Laura is unable to assess the risk of the asset and wants to be certain she’s making a good deal. On the basis of your findings in part a, what is the most she should pay? Why? c. All else being the same, what effect does increasing risk have on the value of an asset? Explain in light of your findings in part a. LG5 6–15 Basic bond valuation Complex Systems has an outstanding issue of $1,000par-value bonds with a 12% coupon interest rate. The issue pays interest annually and has 16 years remaining to its maturity date. a. If bonds of similar risk are currently earning a 10% rate of return, how much should the Complex Systems bond sell for today? CHAPTER 6 Interest Rates and Bond Valuation 301 b. Describe the two possible reasons why similar-risk bonds are currently earning a return below the coupon interest rate on the Complex Systems bond. c. If the required return were at 12% instead of 10%, what would the current value of Complex Systems’ bond be? Contrast this finding with your findings in part a and discuss. LG5 6–16 Bond valuation—Annual interest Calculate the value of each of the bonds shown in the following table, all of which pay interest annually. Bond Par value Coupon interest rate Years to maturity Required return A $1,000 14% 20 12% B 1,000 8 16 8 C 100 10 8 13 D 500 16 13 18 E 1,000 12 10 10 LG5 6–17 Bond value and changing required returns Midland Utilities has outstanding a bond issue that will mature to its $1,000 par value in 12 years. The bond has a coupon interest rate of 11% and pays interest annually. a. Find the value of the bond if the required return is (1) 11%, (2) 15%, and (3) 8%. b. Plot your findings in part a on a set of “required return (x axis)–market value of bond (y axis)” axes. c. Use your findings in parts a and b to discuss the relationship between the coupon i...
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This document was uploaded on 01/19/2014.

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