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Security Valuation - Bonds
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Illustration 11 - Pet feed plc Sir, in the second sub division of this question, I don't understand why we are including the PV of 10000 in the sixth year end, when we don't receive it. Shouldn't we discount the coupon of 1000 for the extended period of 12 years and the FV of 10000 at the 12th year end... and then find the loss??
Answers (2)
"At the end of the 6th year, the present value of future cash flows for the next 6 years was estimated to be 10923 euros at an 8% discount rate. However, if interest rates were to increase, Pet Feed PLC would benefit as their coupon rate is 10% and the market interest rate would be 12%. This would result in a decrease in the bond's value, meaning that at the end of the 6th year, an investment of 10000 euros would earn 12% interest annually. By the end of the 12th year, the investment would be worth 10000 euros, so the present value of annuity for future (PVIAF) and present value of future (PVIF) would total 9181 euros. This would result in a potential loss of 1742 euros, which is the difference between the PV of future cash flows at the end of the 6th year (10923 euros) and the new estimated value (9181 euros). However, the actual loss would be 819 euros, as the investment of 10000 euros would only be worth 9181 euros."
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