Consider a three-year bond with a principal amount of $5,000 and a 4% coupon rate paid annually. If this bond is sold today, it will sell for _________ (rounded to the nearest dollar) in the bond market if current interest rates are 5%.

Question

Quizplus · Accepted Answer

The bond's price can be calculated using the present value of its future cash flows, which include the annual coupon payments and the principal amount at maturity. The formula for the present value of an annuity (the coupon payments) plus the present value of a lump sum (the principal repayment) is used. Given a 4% coupon rate on a $5,000 bond, the annual coupon payment is $200. Using a discount rate of 5% (the current interest rate), the calculation is as follows: Present Value of Coupons = $200 * [(1 - (1 + 0.05)^-3) / 0.05] = $200 * 2.7232 = $544.64 Present Value of Principal = $5,000 / (1 + 0.05)^3 = $5,000 / 1.157625 = $4,319.47 Total Present Value = $544.64 + $4,319.47 = $4,864.11, which rounds to $4,864.

Consider a Three-Year Bond with a Principal Amount of $5,000