A 10-year bond pays 5% on a face value of $1,000. If similar bonds are currently yielding 10%, what is the market value of the bond? Use annual analysis.
A)Less than $900
B)More than $900 and less than $1,100
C)More than $1,100
D)Not enough information is given to tell.

Question

Quizplus · Accepted Answer

If the current yield on bonds is 10%, it means that the market demands a return of 10% on the bond investments. Since the bond in question only pays a 5% coupon, it is less attractive to investors and its market value will decrease to compensate for the lower yield. 
To calculate the market value of the bond: 
PV = PMT/(1 + r)n + FV/(1 + r)n 
where PV is the present value or market value of the bond, PMT is the annual coupon payment, r is the yield or interest rate demanded by the market, n is the number of periods remaining until the bond matures, and FV is the face value or maturity amount of the bond. 
Substituting the values: 
PV = $50/(1 + 0.10)10 + $1,000/(1 + 0.10)10 
PV = $129.68 + $385.54 
PV = $515.22 
Therefore, the market value of the bond is less than $900, which is option A.

A 10-Year Bond Pays 5% on a Face Value of $1,000