Click here to Get Complete Solved Assignments
List of Fresher Jobs, Walk in Interview
Right place for Job Seeker. Fresher Job, Walkin Interview, Exam results.
Visit www.walkinjobstoday.com

SMU MBA Assignments of mb0045 Q.Show the relationship between required rate of return and coupon rate on the value of a bond.


Answer:

The relation between the required rate of interest (Kd) and coupon rate on the value of a bond are displayed below.

• When required rate of interest (Kd) is equal to the coupon rate, the intrinsic value of the bond is equal to its face value.

• When required rate of interest (Kd) is greater than the coupon rate, the intrinsic value of the bond is less than its face value.

• When required rate of interest (Kd) is lesser than the coupon rate, the intrinsic value of the bond is greater than its face value.

Number of years of maturity
• When required rate of interest (Kd) is greater than the coupon rate, the discount on the bond declines as maturity approaches.

• When required rate of interest (Kd) is less than the coupon rate, the premium on the bond declines as the maturity increases.

Example
To show the effect of the above, consider a case of a bond whose face value is Rs. 100 with a coupon rate of 11% and a maturity of 7 years.

If Kd is 13%, then,

      V0 = I*PVIFA (Kd, n) + F*PVIF (Kd, n)
= 11*PVIFA (13%, 7) + 100*PVIF (13%, 7)
= 11*4.423 + 100*0.425
= 48.65 + 42.50
= Rs.91.15


After 1 year, the maturity period is 6 years, the value of the bond is

     V0   = I*PVIFA (Kd, n) + F*PVIF (Kd, n)
= 11*PVIFA (13%, 6) + 100*PVIF (13%, 6)
= 11* 3.998 + 100*0.480
= 43.98 + 48
= Rs. 91.98.

We see that the discount on the bond gradually decreases and value of the bond increases with the passage of time as required rate of interest (Kd) is higher than the coupon rate.

Continuing with the same problem above, let us see the effect on the bond value if the required rate is 8%.

If Kd is 8%,
   V0     = I*PVIFA (Kd, n) + F*PVIF (Kd, n)
= 11*PVIFA (8%, 7) + 100*PVIF (8%, 7)
= 11*5.206 + 100*0.583
= 57.27 + 58.3
= Rs. 115.57

One year later, with Kd at 8%,

   V0     = I*PVIFA (Kd, n) + F*PVIF (Kd, n)
= 11*PVIFA (8%, 6) + 100*PVIF (8%, 6)
= 11*4.623 + 100* 0.630
= 50.85 + 63
= Rs. 113.85

For a required rate of return of 8%, the bond value decreases with passage of time and premium on bond declines as maturity approaches

0 comments:

Post a Comment

Related Posts Plugin for WordPress, Blogger...
 
x

Get Our Latest Posts Via Email - It's Free

Enter your email address:

Delivered by FeedBurner