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DanielleCPA
DanielleCPA, Certified Public Accountant (CPA)
Category: Finance
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Experience:  CPA experienced in tax and financial planning
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Two years ago your corporate treasurer purchased for the firm

Resolved Question:

Two years ago your corporate treasurer purchased for the firm a 20-year
bond at its par value of$1,000. The coupon rate on this security is 8 percent. Interest payments are made to bondholders once a year. Currently, bonds of this particular risk class are yielding investors 9 percent. A cash shortage has forced you to instruct your treasurer to liquidate the bond.
a. At what price will your bond be sold? Assume annual compounding.
b. What will be the amount of your gain or loss over the original purchase price?
c. What would be the amount of your gain or loss had the treasurer originally purchased a
bond with a 4—year rather than a 20-year maturity? (Assume all characteristics of the bonds
are identical except their maturity periods.)
d. What do we call this type of risk assumed by your corporate treasurer?
Submitted: 5 years ago.
Category: Finance
Expert:  DanielleCPA replied 5 years ago.

Hi and welcome to Just Answer! I'm happy to help answer your Finance questions. Feel free to ask for clarification if needed.

 

 

A)

Calculating the bond's present value is a two-step process. First, we need to calculate the present value of the bond's maturity value of 1,000. We do this by using the present value of $1 factor for 9% the market rate and 18 years. The factor is .212.

1,000 * .212 = 212

Next we need to calculate the present value of the interest payments using the present value of the bond's annual interest payments of 80 (1000 * 8%). We need the present value of annuity factor for 9% market rate and 18 years. The factor is 8.756.

80 * 8.756 = 700.48

So the total present value of the bond is 212 + 700.48 or 912.48

Present Value Tables

 

B.

Loss over purchase price

912.48 sales price less 1,000 sales price= 87.52 loss

 

C.

Present value of maturity value:

1,000 * .842 = 842

Present value of interest payments

80 * 1.759 = 140.72

Total sales price at present value: 842+140.72 = 982.72

Loss= 982.72 sales price - 1,000 purchase price = 17.28 loss

 

D.

Interest rate risk

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