Midland Utilities has outstanding a bond issue that will mature to its $1,000
par value in 12 years.
The bond has a coupon
interest rate of 11% and pays interest annually.
Find the value of the bond if the required return is (1) 11%, (2) 15%, and (3) 8%.
Plot your findings in part a on a set of “required return (x axis)–market value of bond (y axis)” axes.
Use your findings in parts a and b to discuss the relationship between the coupon interest rate on a bond and the required return and the market value of the bond relative to its par value.
What two possible reasons could cause the required return to differ from the coupon interest rate?