Show all steps If today is October 2002 what is the value of

If today is October 2002, what is the value of the following bond? An IBM Bond pays $115 every Sept for 5 years. In Sept 2007 it pays an additional $1000 and retires the bond. The bond is rated AAA (WSJ

Solution

1) Value of the IBM Bond is the sum of the following: PV of the yearly interest of $115 for 5 years, which is an annuity. The PV of the annuity using the formula for finding PV of annuity = 115*(1.075^5-1)/(0.075*1.075^5) = $       465.28 The PV of the redemption value of $1000.which is equal to 1000/1.075^5 = $       696.56 Value of the IBM Bond $   1,161.84 2) The price of the stock is the PV of the expected cash flows from the bond for the 3 years, which includes the dividends and the sale value at the end of the 3rd year, discounted at 12%. Therefore, the price = 3/1.12+3.24/1.12^2+(3.50+94.48)/1.2^3 = $         61.96 3) The expected return = (Expected dividend+Expected capital gain)/Initial price = (5+110-100)/100 = 15.00%