An investor purchases a 12-year, $1,000 par value bond that pays semiannual interest of $40. If the semiannual market rate of interest is 5%, what is the current market value of the bond

Value of the bond = $862.013

Explanation:

The value of the bond is the present value of the future cash receipts expected from the bond. The value is equal to present values of interest payment and the redemption value (RV).

Value of Bond = PV of interest + PV of RV

The value of the bond can be worked out as follows:

Step 1

Calculate the PV of Interest payment

Present value of the interest payment

PV = Interest payment * (1 - (1+r) ^ (-n)) / r

Interest payment = $40

PV = 40 * (1 - (1.05) ^ (-12*2) / 0.05)

= 40 * 13.7986

= 551.945

Step 2

PV of redemption Value

PV of RV = RV * (1+r) ^ (-n)

= 1000 * (1.05) ^ (-12*2)

= 310.067

Step 3

Calculate Value of the bond

= 551.94567 + 310.067

=862.01

Value of the bond = $862.013