You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800.The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value.You should buy the bond if your required return on bonds with this risk is 12%.

Question

Quizplus · Accepted Answer

The bond is currently selling at a discount, which means its yield to maturity is higher than the coupon rate. If the required return on bonds with this risk is 12%, and the bond's yield to maturity (which is the same as the required return if the bond is held to maturity) is higher than 12%, then the bond is a good buy. In this case, the bond's yield to maturity can be calculated as follows:

PV = 800
FV = 1000
n = 10
i = ?
PMT = 100

Solving for i using a financial calculator or spreadsheet function, we get i = 13.41%, which is higher than the required return of 12%. Therefore, the bond should be purchased.

You Have Funds That You Want to Invest in Bonds