Raul has recently inherited RM10,000 and is considering purchasing 10 bonds of the
Twilight Corporation. The bond has a par value of RM1,000 with 10 percent coupon rate
and will mature in 10 years. Does Raul have enough money to buy 10 bonds if the required
rate of return is 9 percent?
The cash flow for each of the years is as follows:
Year One = RM100 (which is a par value x coupon rate) Year Two = RM100 Year Three = RM100 Year Four = RM100 Year Five = RM100 Year Six = RM100 Year Seven = RM100 Year Eight = RM100 Year Nine = RM100 Year Ten = RM1100 (par value + coupon)
Thus, the PV of the cash flows is as follows (expected cash flows in period T / (1 + rate of return) to the T power):
Year One = RM91.74 Year Two = RM84.17 Year Three = RM77.22 Year Four = RM70.87 Year Five = RM64.98 Year Six = RM59.63 Year Seven = RM54.7 Year Eight = RM50.19 Year Nine = RM46.04 Year Ten = RM464.72
Now to find the value of the bond: Value = RM91,74 + RM84,17 + ... Value = RM1,064.26
Therefore, Raul doesn't have enough money to buy 10 bonds (he can only afford 9)
Answer: No, Raul doesn't have enough money to buy 10 bonds if the required rate of return is 9 percent.