A 7-year, 5% coupon bond (payable semi-annually) that was issued 4 years ago is presently trading at a YTM of 9%. Bond has a face value of $1000. Compute the bond's price.

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BlackTom AI · Accepted Answer

Question restatement:
A 7-year, 5% coupon bond (semi-annual coupons) issued 4 years ago with face value of $1000 is currently priced with a YTM of 9%. Compute the bond's price.

Key data to extract:
- Coupon rate: 5% annual on par -> $50 per year = $25 every semi-annual period.
- Semi-annual coupon: $25 every 6 months.
- Time to maturity remaining: The bond has a total term of 7 years and was issued 4 years ago, so 3 years remain. Since coupons are semi-annual, there are 3 × 2 = 6 remaining coupon payments.
- YTM: 9% annual, compounded semi-annually implies a periodic yield of 9%/2 = 4.5% per half-year.
- Par value: $1000, to be received at maturity.

Step-by-step calculation:
1) Compute the present value of the 6 remaining coupon payments of $25 each discounted at 4.5% per half-year.
   The formula for an ordinary annuity present value is: PV_coupons = C × [1 − (1 + i)^−n] / i, where C = 25, i = 0.045, n = 6.
   (1 + i)^6 = 1.045^6 ≈ 1.30226, so (1 + i)^−6 ≈ 1 / 1.30226 ≈ 0.7676.
   Therefore [1 − (1 + i)^−n] ≈ 1 − 0.7676 ≈ 0.2324.
   PV_coupons ≈ 25 × (0.2324 / 0.045) ≈ 25 × 5.154 ≈ 128.85.

2) Compute the present value of the par value to be received at maturity, discounted 6 periods at 4.5% per period:
   PV_par = 1000 × (1 + i)^−n = 1000 × 0.7676 ≈ 767.60.

3) Sum the two present values to obtain the bond price:
   Price ≈ PV_coupons + PV_par ≈ 128.85 + 767.60 ≈ 896.45.

Rounding considerations:
- Depending on rounding during intermediate steps, you may see a result very close to $896.4x. The provided answer of $896.84 is consistent with typical rounding choices or a slightly different intermediate rounding, but the method and the order of magnitude are correct.

Notes on potential pitfalls or alternative interpretations:
- If one misreads the remaining periods or miscalculates the semi-annual yield, the price will differ. For example, forgetting that there are 6 remaining coupon periods or using 9% as a semi-annual rate would lead to an incorrect result.
- If the bond had a different remaining time to maturity, the number of coupon payments and the discounting would change accordingly, producing a different price.

Summary:
Using 6 remaining semi-annual coupons of $25 and a semi-annual discount rate of 4.5%, the price is computed as approximately $896.45, which aligns closely with the provided answer of about $896.84 when rounded differently.

FA25-BL-BUS-F305-1130 Problem Set 5 (Please read the instruction)

A 7-year, 5% coupon bond (payable semi-annually) that was issued 4 years ago is presently trading at a YTM of 9%. Bond has a face value of $1000. Compute the bond's price.

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FA25-BL-BUS-F305-1130 Problem Set 5 (Please read the instruction)

A 7-year, 5% coupon bond (payable semi-annually) that was issued 4 years ago is presently trading at a YTM of 9%. Bond has a face value of $1000. Compute the bond's price.

View Explanation

Log in for full answers

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