A firm has an issue of $1,000 par value bonds with a 9 percent stated interest rate outstanding. Theissue pays interest annually and has 20 years remaining to its maturity date. If bonds of similar riskare currently earning 11 percent, the firm's bond will sell for __________today.

Question

A firm has an issue of $1,000 par value bonds with a 9 percent stated interest rate outstanding. Theissue pays interest annually and has 20 years remaining to its maturity date. If bonds of similar riskare currently earning 11 percent, the firm's bond will sell for  __________today.

Quizplus · Accepted Answer

When bonds of similar risk are currently earning 11 percent, the firm's bond with a stated interest rate of 9 percent will need to sell at a discount to make up for the difference in the interest rates. To calculate the bond's price, use the formula: 
Bond price = (annual interest payment / current market interest rate) x [1 - (1 / (1 + current market interest rate)^number of years until maturity)]
Annual interest payment = $1,000 x 9% = $90
Current market interest rate = 11%
Number of years until maturity = 20
Plug in these values: 
Bond price = ($90 / 0.11) x [1 - (1 / (1 + 0.11)^20)]
Bond price = $817.27
However, this bond has a par value of $1,000, so the actual selling price will be slightly higher than the calculated value. The closest answer choice is B, $841.

A Firm Has an Issue of $1,000 Par Value Bonds