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To value a bond we have to find the present value of the future cash flows that this bond would pay the investor. In other words, we need to find the present value of the coupons using the annuity present value formula and the principal present value using the single-amount present value formula.
Find the value of a bond that pays a coupon of 4% per year, semi-annually, and has a maturity of 14 years. At this time the market interest rate or expected yield (YTM – yield to maturity) is 5% per year APR (annual, compounded semi-annually) the par value is $1,000.
If the market rate drops to 4% APR, then what would the price be?
If the market rate drops to 3% APR, then what would the price be?
What behavior of the value of the bond can you observe when the market rate falls from 4% APR to 3% APR?