Principle of Banking & Finance: Debt Discharge & Bond Pricing

This assignment solution focuses on the principles of banking and finance, specifically addressing debt discharge and bond pricing. It calculates the annual payment required to discharge a debt of $6,000 over three years at an 8% interest rate, determining the payment to be $2,328.20 and providing an amortization table with a total interest paid of $984.60. Furthermore, the assignment analyzes a bond with a par value of $1,000, a 9% annual coupon, and 14 years to maturity, currently priced at $1,120. It calculates the yield to maturity (YTM) to be 7.58% and determines that if an investor requires an 8.5% return, the bond should be priced at $1,040.05. The assignment concludes that the investor should not invest in the bond at its current price, as the YTM is lower than the required rate of return. The analysis is supported by relevant academic references.

PRINCIPLE OF BANKING & FINANCE
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Question 1
The determination of the annual payment for discharging the debt can be made using the
following formula (Parrino & Kidwell, 2014).
PVA = PMT (1-(1/(1+r)n))/r
Based on the information provided, PVA = 60% *10,000 = $6,000, i= 8% p.a., n=3
Hence, 6000 = PMT (1-(1/1.083))/0.08
Solving the above, PMT = $2,328.20
The amortisation table is indicated below.
Total interest paid in three years = 480 + 332.14 +172.46 = $ 984.60
Question 2
The given information about the bond is summarised below.
Par value= $ 1,000
Annual coupon payment = (9/100)*1000 = $ 90
Time of maturity = 14 years
Current price = $ 1,120
a) The requisite formula for pricing of bond is indicated below (Brealey, Myers & Allen,
2014)

Based on the information provided, C = $ 90, n=14, M=$1,000, Bond Price = $1,120, i
=YTM
1120 = [90*(1-(1/(1+YTM))14/YTM] + (1000/(1+YTM)14)
The above has been solved using hit and trial considering the fact that since the bond is
trading at a premium, hence YTM would be lower than 9%.
Solving the above, we get YTM = 7.58% p.a.
b) In the given case, the required return is 8.5%. The requisite formula for pricing of bond is
indicated below.
Based on the information provided, C = $ 90, n=14, M=$1,000, i=8.5%
Hence, bond price = [90*(1-(1/1.085)14)/0.085] + [1000/(1.085)14]
Thus, bond price = [90*(1-0.319142)/0.085] + [1000/3.1334]
Further, bond price = (61.277/0.085) + 319.14
Solving the above, we get bond price = $1,040.05
c) From the output obtained in part (b), it is evident that for the investor to obtain a 8.5% rate
of return, the price needs to be $1,040.05. However, as indicated in part (a), the current price
of the bond is $ 1,120 and the YTM is lower than 8%. Therefore, the investor must not make
the investment (Damodaran, 2015).

References
Brealey, R. A., Myers, S. C. & Allen, F. (2014) Principles of corporate finance, 6th ed. New
York: McGraw-Hill Publications
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York:
Wiley, John & Sons.
Parrino, R. & Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London:
Wiley Publications