Example of Valuation of Bonds and Debentures

K is contemplating purchasing a 3 year bond worth 40,000/= carrying a nominal coupon rate of interest of 10 percent.  K necessary rate of return is 6 percent.

What must he be willing to pay currently to purchase the bond if it matures at par?

Solution

Int  =       10 percent x 40,000 = 4,000 p.a.

n    =        3 yrs

K_d  =        6 percent

M   =        40,000

V_d  = 4,000 / (1.06)¹ + 4,000 / (1.06)² +4,000 / (1.06)³ +4,000 / (1.06)³      

      = 4,000 x PVAF6%,3 + 40,000 x PVIF6%,3 = (40,000 x 2.673) + (40,000 x 0.840)

      = 44,292