This homework problem has given me nothing but a headache!!! Can anyone help?!?

Question

Wilson Company will issue $300,000,000 of 7%, $1000 Par bonds on November 15, 2004. The bonds will pay interest semiannually and mature on November 15, 2011.
a) What is the value of an individual bond from this issue to an investor who purchases the Wilson bond on the date of issue (November 15, 2004) assuming they require an 8% return?
b) Without doing the calculation would the value of the bond go up, go down or stay the same if the required interest rate increased to 12%. Explain.
c) Without doing the calculation would the value of the bond go up, go down or stay the same if the maturity date was changed to November 15, 2009. Explain.

Answer 1

a) The rough answer is $990. The investor needs to earn 1% more than the bond pays (8% - 7%), so on the day of issue the bond would be worth 1% less than Par. There are some other factors that are at work here, and I don't remember all the math exactly. But this will give you a good ball park to test your answer with.

b) If interest rates go up, bond value goes down. Would you pay full price for a 10% bond when you can get a 12% bond at the same price?

c)The value of the bond would increase with the shorter term. That's because the shorter term reduces the risk of interest rates climbing higher during the life of the bond. (Again higher interest rates drive bond prices down).

Hope this helps!

Answer 2

A)The bonds are worth less than face value otherwise they couldn't get a higher return,
I don't feel like doing the math.
B) The value would go down when yield goes up
C) The value would be down less when the term is shorter.

Think about it if I offered you a bond that paid 12% interest when you could only get 3% in the bank wouldn't you be willing to give me a little more for the bond if I let you keep getting that great rate for the next 50 years you would really be willing to pay more.