You are contemplating the purchase of a 20-year bond that pays $50 in interest each six months.You plan to hold this bond for only 10 years,at which time you will sell it in the marketplace.You require a 12 percent annual return,but you believe the market will require only an 8 percent return when you sell the bond 10 years hence.Assuming you are a rational investor,how much should you be willing to pay for the bond today?

Question

Quizplus · Accepted Answer

To determine the price you should be willing to pay for the bond today, you need to calculate the present value of the bond's cash flows, considering both the interest payments you will receive over the next 10 years and the price you expect to sell the bond for at the end of those 10 years. The bond pays $50 every six months, which is $100 per year. Since you plan to hold the bond for 10 years, you will receive these payments 20 times. The expected selling price in 10 years can be calculated using the market's required return of 8 percent at that time. The present value of the bond's cash flows can be calculated using the required annual return of 12 percent (or 6 percent semi-annually) for your investment period. The correct calculation involves discounting the semi-annual interest payments and the expected selling price back to the present value at your required return rate. The correct answer, $927.68, reflects this calculation, taking into account the time value of money and the expected future market conditions.

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