a You are considering the following investment a bond that

a) You are considering the following investment - a bond that guarantees a payout of $100 three years from today. You have decided that you are willing to lend a nominal interest rate no less than 3% (i.e. i = .03). Calculate the present value.

b) Continue with the previous question. If the bond is actually trading for $88, would you be willing to buy it? Why or why not?

Solution

(a) Let Present value be P. Then,

$100 = $P x (1.03)³

100 = P x 1.0927

P = 100 / 1.0927 = $91.52

(b) Since expected bond price is higher than current trading price, I would buy the bond now because it\'s trading undervalued.