Solutions Guide: Please reword the answers to essay type ...
Solutions Guide: Please reword the answers to essay type parts so as to guarantee that your answer is an original. Do not submit as your own.
Lynn Parsons is considering investing in either of two oustanding 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. a. Calculate the value of bond A if the required return is (1) 8%, (2) 11%, and (3) 14%. b. Calculate the value of bond B if the required return is (1) 8%, (2) 11%, and (3) 14%. 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 8% ? ? 11% ? ? 14% ? ?
Bo = I x (PVIFAkd%,n) + M x (PVIFkd%,n)
Calculator
a. Bond Table Values Solution
(1) B0 = $110 x (3.993) + $1,000 x (.681) = $1,120.23 $1,119.78
(2) B0 $110 x (3.696) + $1,000 x (.593) = $1,000.00 $1,000.00
(3) B0 = $110 x (3.433) + $1,000 x (.519) = $ 896.63 $ 897.01
Calculator
b. Bond Table Values Solution
(1) B0 = $110 x (8.560) + $1,000 x (.315) = $1,256.60 $1,256.78
(2) B0 $110 x (7.191) + $1,000 x (.209) = $1,000.00 $1,000.00
(3) B0 = $110 x (6.142) + $1,000 x (.140) = $ 815.62 $ 815.73
c. Value
Required Return Bond A Bond B
8% $1,120.23 $1,256.60
11% 1,000.00 1,000.00
14% 896.63 815.62
The greater the length of time to maturity, the more responsive the market value of the bond to changing required returns, and vice versa.
d. If Lynn wants to minimize interest rate risk in the future, she would choose Bond A with the shorter maturity. Any change in interest rates will impact the market value of Bond A less than if she held Bond B.
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