An Investor Is Considering The Purchase Of Five Years Tk. 1000 Per Value Bond, Bearing A Normal Rate Of Interest Of 7%

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An investor is considering the purchase of five years Tk. 1000 per value Bond, bearing a normal rate of interest of 7%. The investor’s required rate of return is 8%. What should he be willing to pay now to purchase? The bond if it matrices at par? The investors will receive cash Tk. 70 as interest each year or 5 years a Tk. 1000 on maturity.

To determine what the investor should be willing to pay today, we calculate the Intrinsic Value (Present Value) of the Bond.

The price of a bond equals the present value of its future cash flows: the annual interest payments (an ordinary annuity) plus the principal amount repaid at maturity (a single lump sum), both discounted at the investor’s required rate of return.

1. Given Data

Par / Face Value (): Tk. 1,000
Coupon Rate: 7%
Annual Interest Payment ():
Required Rate of Return (): 8% or
Maturity Period (): 5 years

2. Bond Valuation Formula

Where:

3. Calculation

Present Value of Annual Interest Payments:

Present Value of Maturity Amount (Principal):

Total Value of the Bond ():

Conclusion

The investor should be willing to pay Tk. 960.07 to purchase the bond today.

(Since the investor’s required rate of return (8%) is higher than the coupon rate (7%), the bond sells at a discount relative to its Tk. 1,000 par value).