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Unformatted text preview: nterest rate on a bond and the required return and the market value
of the bond relative to its par value.
d. What two possible reasons could cause the required return to differ from the
coupon interest rate? LG5 6–18 Bond value and time—Constant required returns Pecos Manufacturing has just
issued a 15-year, 12% coupon interest rate, $1,000-par bond that pays interest
annually. The required return is currently 14%, and the company is certain it
will remain at 14% until the bond matures in 15 years.
a. Assuming that the required return does remain at 14% until maturity, find
the value of the bond with (1) 15 years, (2) 12 years, (3) 9 years, (4) 6 years,
(5) 3 years, and (6) 1 year to maturity.
b. Plot your findings on a set of “time to maturity (x axis)–market value of
bond (y axis)” axes constructed similarly to Figure 6.6.
c. All else remaining the same, when the required return differs from the coupon
interest rate and is assumed to be constant to maturity, what happens to the
bond value as time moves toward maturity? Explain in light of the graph in
part b. LG5 6–19 Bond value and time—Changing required returns Lynn Parsons is considering
investing in either of two outstanding bonds. The bonds both have $1,000 par
values and 11% coupon interest rates and pay annual interest. Bond A has
exactly 5 years to maturity, and bond B has 15 years to maturity. 302 PART 2 Important Financial Concepts a. Calculate the value of bond A if the required return is (1) 8%, (2) 11%, and
b. Calculate the value of bond B if the required return is (1) 8%, (2) 11%, and
c. From your findings in parts a and b, complete the following table, and discuss the relationship between time to maturity and changing required returns.
Required return Value of bond A Value of bond B ? ? 11 8% ? ? 14 ? ? d. If Lynn wanted to minimize interest rate risk, which bond should she purchase? Why?
LG6 6–20 Yield to maturity The relationship between a bond’s yield to maturity...
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