Doug has been approached by his broker to purchase a $1,000 bond for $795. He believes the bond should yield 8%. The bond pays a 5% annual coupon rate and has 10 years left until maturity. What should Doug's analysis of the bond indicate to him? Use annual analysis. Use time value of money tables in Appendix B and Appendix D.
A) The bond is undervalued; he should purchase it.
B) The bond is undervalued; he should not purchase it.
C) The bond is overvalued; he should purchase it.
D) The bond is overvalued; he should not purchase it.

Question

Quizplus · Accepted Answer

PV of interest payments: 1,000 × 0.05 = $50. Using PV of annuity table, I = 8%, n = 10 years, factor 6.710 × $50 = 335.5
PV of principal: Using PV of $1 table, I = 8%, n = 10 years, factor 0.463 × 1,000 = 463.
Total value of the bond: 798.5 (335.5 + 463), so higher than sales price.

Doug Has Been Approached by His Broker to Purchase a $1,000