You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.

Question

Coby Hoffman

Business

5 February, 17:52

You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.

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Answers (1)

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Zachariah Dunlap · Answer 1

The answer is: Yes, you should buy this bond.

Explanation:

In order to buy the bond, you are going to invest $800

Each year, during 9 consecutive years, you will earn $100 in interest.

At the end of year 10, you will receive $1,000.

To find out if this bond is a good investment, you must calculate its net present value (NPV) using this formula: NPV = ∑ (P / (1+i) t) - C, were:

P = periodic cash flows (100, 100, 100, 100, 100, 100, 100, 100, 100, 1000) i = discount rate = 12% t = number of time periods = 10 C = capital = 800

The NPV of this investment is $54.80, that means it is good investment for you. Any investment with a NPV ≥ 0 is considered a good investment.