Answer:
Intrinsic value = $1085.87
Explanation:
Annual Rate of return = 3.00%
Annual Coupon rate = 6.00%
Now, consider the situation in which Olivia wants to earn a return of 3.00%, but the bond being considered for purchase offers a coupon rate of 6.00%. Again, assume that the bond pays semiannual interest payments and has three years to maturity. If you round the bonds intrinsic value to the nearest whole dollar, then its intrinsic value of $1085.87 (rounded to the nearest whole dollar) is HIGHER THAN its par value, so that the bond is TRADING AT PREMIUM
Intrinsic value = [tex]\frac{A}{(1+C)^1} + \frac{A}{(1+C)^2} + \frac{A}{(1+C)^3} +\frac{A}{(1+C)^4} + \frac{A}{(1+C)^5} + \frac{A}{(1+C)^6}[/tex] [tex]+ \frac{B}{(1+c)^6}[/tex]
= 30/ (1.015) + 30/(1.015)^2 + ------- + 30/ (1.015)^6 + 1000/(1.015)^6
= 29.56 + 30/1.030 + 30/1.046 + 30/1.061 + 30/1.077 + 30/1.093 + 1000/1.093
= 29.56 + 29.126 + 28.68 + 28.275 + 27.855 + 27.447 = $170.96 + $914.91
= $1085.87
Bond's par value = $1000
annual coupon rate = 6% = 0.06
semiannual coupon rate = 3% = 0.03
semiannual coupon ( A ) = 0.03 * $1000 = $30
Annual rate of return = 3% = 0.03
semi-annual rate of return ( C )= 1.5% = 0.015
