University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

348

Pages:

2
Author:

stud_ice13

Bond Pricing Overview The price of a bond is the present value of all future cash flows, which includes: 1. The face (par) value of the bond to be paid at maturity. 2. Periodic interest payments, usually semiannual, based on the bond’s stated interest rate (coupon rate). These cash flows are discounted using the market interest rate applicable at the time of issuance, which may differ from the coupon rate. Bond pricing involves calculating: • • Present Value of Par Value: The amount paid at maturity, discounted to the present. Present Value of Interest Payments: A series of interest payments, treated as an annuity and discounted to the present. Example 1: Pricing a Discount Bond (Fila Bond) Details: • • • • Face Value (Par): $100,000 Coupon Rate: 8% (semiannual payments of $4,000) Market Rate: 10.031% annually (5.0155% semiannually) Term: 2 years (4 semiannual periods) Step 1: Calculate Present Value of Par Value Using Table B.1 or a calculator, the present value factor for a single payment at the end of four periods at a 5.0155% rate is 0.8222. Present Value of Par=Face Value×PV factor=100,000×0.8222=82,220 Step 2: Calculate Present Value of Interest Payments The present value factor for an annuity of four semiannual payments at a 5.0155% rate is 3.5449. Present Value of Interest Payments=Semiannual Payment×Annuity PV factor=4,000×3.5449=14 ,180 Step 3: Calculate Bond Price Bond Price=Present Value of Par+Present Value of Interest Payments=82,220+14,180=96,400 Example 2: Pricing a Premium Bond (Adidas Bond) Details: • • • • Face Value (Par): $100,000 Coupon Rate: 12% (semiannual payments of $6,000) Market Rate: 9.97% annually (4.9851% semiannually) Term: 2 years (4 semiannual periods) Step 1: Calculate Present Value of Par Value The present value factor for a single payment at the end of four periods at a 4.9851% rate is 0.8232. Present Value of Par=Face Value×PV factor=100,000×0.8232=82,320 Step 2: Calculate Present Value of Interest Payments The present value factor for an annuity of four semiannual payments at a 4.9851% rate is 3.5467. Present Value of Interest Payments=Semiannual Payment×Annuity PV factor=6,000×3.5467=21 ,280 Step 3: Calculate Bond Price Bond Price=Present Value of Par+Present Value of Interest Payments=82,320+21,280=103,600 Summary • • Fila Bond Price (Discount): $96,400 Adidas Bond Price (Premium): $103,600 The discount bond price is below par because its coupon rate is lower than the market rate, meaning investors pay less to account for the lower interest income. The premium bond price is above par, as it has a higher coupon rate than the market rate, allowing investors to receive additional interest payments, which increases the bond’s value above face value.