202 Part 3 Financial Assets
investor, it is shown with a negative sign. The calculator is programmed to solve
Equation 7-1: It! nds the PV of an annuity of $100 per year for 15 years discounted
at 10%; then it! nds the PV of the $1,000 maturity payment; then it adds those two
PVs to! nd the bond’s value.
In this example, the bond is selling at a price equal to its par value. Whenever
the bond’s market, or going, rate, rd, is equal to its coupon rate, a! xed-rate bond
will sell at its par value. Normally, the coupon rate is set at the going rate in the
market the day a bond is issued, causing it to sell at par initially.
The coupon rate remains! xed after the bond is issued, but interest rates in the
market move up and down. Looking at Equation 7-1, we see that an increase in the
market interest rate (rd) causes the price of an outstanding bond to fall, whereas a
decrease in the rate causes the bond’s price to rise. For example, if the market inter-
est rate on Allied’s bond increased to 15% immediately after it was issued, we
would recalculate the price with the new market interest rate as follows:N I/YR PV PMT FV15 15 100 1000Output: = –707.63Inputs:The bond’s price would fall to $707.63, well below par, as a result of the increase in
interest rates. Whenever the going rate of interest rises above the coupon rate, a
! xed-rate bond’s price will fall below its par value; this type of bond is called a
discount bond.Discount Bond
A bond that sells below
its par value; occurs
whenever the going rate
of interest is above the
coupon rate.Discount Bond
A bond that sells below
its par value; occurs
whenever the going rate
of interest is above the
coupon rate.Payments 100Present!
Value100 1,0001,000.00 when rd! 10%100 100 100 100 100 100 100 100 100 100 100 100 1001/3/101/11 1/12 1/13 1/14 1/15 1/16 1/17 1/18 1/19 1/20 1/21 1/22 1/23 1/2/2024
"
90.91
82.64
75.13
68.30
62.09
56.45
51.32
46.65
42.41
38.55
35.05
31.86
28.97
26.33
23.94
239.39Time Line for Allied Food Products’ Bonds, 10% Interest Rate
F I G U R E 7! 1