2005-lecture11

# Bond values fluctuate inversely with interest rates

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The purchase price of bonds is market driven and is a function of interest rates. Bond values fluctuate inversely with interest rates because the bond coupon rate for any given bond is fixed. As market interest rates increase, bond purchase values decline and as market interest rates decrease, bond purchase values increase. Finding the present worth value of a bond is another extension of present worth analysis. To calculate the PW of a bond: 1. Determine I, the amount of interest paid per payment period. 2. Construct a cash flow diagram of interest payments and the face value repayment at maturity. 3. Establish the MARR. 4. Calculate the present worth of the bond using i = MARR. Compare the calculated PW of the bond to the offer price to determine whether to purchase the bond. Example: Determine whether to purchase a \$10,000, 6% per year (payable semi-annually), 10- year bond offered at \$9,000 if your MARR is 8% per year, compounded semi-annually. 1. ( 29 ( 29 \$10,000 0.06 \$300 2 I = = 7 Ohlinger

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Lecture 11 2. 3. MARR = 8% per year, compounded semi-annually Effective i = 4% per 6 months. 4. PW = \$300(P/A, 4%, 20) + \$10,000(P/F, 4%, 20) PW = \$300(13.5903) + \$10,000(0.4564) = \$4,077 + \$4,564 = \$8,641 The \$9,000 offer price is greater than the PW based on your MARR – do not purchase the bond. Reading: Chapter 5, pages 177 - 197 Homework: Chapter 5, Problems 5.20, 5.22, 5.33, 5.36, 5.39, 5.48, 5.50; Due November 16, 2005 8 Ohlinger 0 MARR = 8% 1 5 10 15 20 P = ? \$300 \$10,000
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