Pierre Dupont just received a cash gift from his grandfather. He plans to invest in a five-year bond issued by Venice Corp. that pays a coupon rate of 5.5 percent. If the current market rate is 7.25 percent, what is the maximum amount Pierre should be willing to pay for this bond?

$928.71

Explanation:

The maximum amount that the Pierre should pay for the bond is equal to present value of all the cash flows associated with this bond over a life of 5 years of bond.

Assuming that the par value of the bond is $1,000, the coupon rate payment associated with this bond is, 5.5%*1,000=$55 per year for 5 years and the bond will mature at its par value of $1,000 at the end of its 5th year.

Year                  Cash Flows                         Present [email protected]%

1-5                        $55                                              $224

5                           $1,000                                         $704.71

Maximum amount that Pierre should pay            $928.71

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