Bond Valuation Calculation

C

The value of bond is equal to the present value of the stream of coupon payments (which can be thought of as an annuity for a certain number of years) plus the present value of the final payment. The required rate of return on the bond is equal to the risk-free rate of return plus the risk-premium (7+5=12% for the year, 6% for six months). Using appendix C in the book by Reilly & Brown, the present value of the coupons is $100 x 10.106 = $1,010.60. The present value of the final payment is $2,000 x 0.4039 = $807.80, or $2,000/(1.06^16). The value of the bond is 1010.60 + 807.80 = $1818.40. Note that many textbooks recommend using the six-month interest rate and doubling the number of yearly periods in making this calculation. Using 6% for 16 periods, the value of the final payment is $787.40 and the total value of the bond is 1010.60 + 787.40 = $1,798.