Problem 1: Assume Venture Healthcare Sold Bonds That Have A

Problem 1assume Venture Healthcare Sold Bonds That Have A Ten Year Mat

Assume Venture Healthcare sold bonds that have a ten-year maturity, a 12 percent coupon rate with annual payments, and a $1,000 par value. a. Suppose that two years after the bonds were issued, the required interest rate fell to 7 percent. What would be the bond's value? b. Suppose that two years after the bonds were issued, the required interest rate rose to 13 percent. What would be the bond's value? c. What would be the value of the bonds three years after issue in each scenario above, assuming that interest rates stayed steady at either 7 percent or 13 percent?

Paper For Above instruction

Venture Healthcare issued bonds with a face value of $1,000, a ten-year maturity, and a 12 percent annual coupon rate. The valuation of these bonds at different points depends heavily on prevailing interest rates, which influence their market price over time. Understanding how bond prices fluctuate with changes in interest rates is fundamental in finance, providing insight into the risks and returns associated with bond investing.

Part A: Bond Value When Interest Rates Fall to 7 Percent After Two Years

Initially, Venture Healthcare's bonds offer a 12 percent coupon rate, resulting in annual payments of $120. When market interest rates decline to 7 percent after two years, the bond's value increases because its fixed coupon payments are more attractive compared to new bonds issued at lower rates. To determine the bond's value at this point, we must calculate the present value (PV) of the remaining cash flows—the remaining coupon payments and the face value—discounted at the new market rate of 7 percent.

The bond has an original ten-year maturity. After two years, eight years remain until maturity. The bondholder continues to receive annual coupons of $120, and at the end of year eight, the principal of $1,000 is returned.

The present value of the bond can be calculated as the sum of the present value of an annuity (the coupons) and the present value of a lump sum (the face value). The formulas are:

• PV of coupons = C × [1 - (1 + r)^-n] / r
• PV of face value = F / (1 + r)^n

Where:

• C = annual coupon payment = $120
• r = market interest rate = 0.07
• n = number of remaining years = 8
• F = face value = $1,000

Calculating:

• PV of coupons = 120 × [1 - (1 + 0.07)^-8] / 0.07 ≈ 120 × 5.7467 ≈ $689.60
• PV of face value = 1,000 / (1 + 0.07)^8 ≈ 1,000 / 1.7138 ≈ $583.60

Adding these together, the bond's value is approximately:

Bond Value ≈ $689.60 + $583.60 ≈ $1,273.20

Part B: Bond Value When Interest Rates Rise to 13 Percent After Two Years

Similarly, if interest rates increase to 13 percent, the bond's market value declines because its fixed coupon rate is less attractive relative to new bonds issued at the higher rate. The calculations follow the same process, with the new discount rate of 13 percent:

• PV of coupons = 120 × [1 - (1 + 0.13)^-8] / 0.13 ≈ 120 × 4.57 ≈ $548.40
• PV of face value = 1,000 / (1 + 0.13)^8 ≈ 1,000 / 2.635 ≈ $379.80

Thus, the bond's approximate value is:

Bond Value ≈ $548.40 + $379.80 ≈ $928.20

Part C: Bond Values Three Years After Issue in Both Scenarios

When evaluating the bond's value three years after issuance, it's essential to consider that interest rates remain steady at either 7 percent or 13 percent from that point forward, and the bond matures in seven years (since initially there were ten years to maturity).

In both cases, the remaining cash flows consist of annual coupons of $120 and face value of $1,000, with seven years remaining. The calculations are analogous to previous steps, replacing n=7:

• PV of coupons = 120 × [1 - (1 + r)^-7] / r
• PV of face value = 1,000 / (1 + r)^7

When interest rates stay at 7 percent:

• PV of coupons = 120 × [1 - (1 + 0.07)^-7] / 0.07 ≈ 120 × 5.2124 ≈ $625.49
• PV of face value = 1,000 / (1 + 0.07)^7 ≈ 1,000 / 1.6137 ≈ $620.11

Bond value at 7% interest rate after 3 years: ≈ $1,245.60

When interest rates stay at 13 percent:

• PV of coupons = 120 × [1 - (1 + 0.13)^-7] / 0.13 ≈ 120 × 4.29 ≈ $514.80
• PV of face value = 1,000 / (1 + 0.13)^7 ≈ 1,000 / 2.171 ≈ $460.57

Bond value at 13% interest rate after 3 years: ≈ $975.37

In conclusion, the value of Venture Healthcare's bonds is highly sensitive to changes in market interest rates. When rates fall, bond prices increase, and vice versa. The calculations above provide clear examples of this inverse relationship, emphasizing the importance for investors to consider interest rate movements when investing in bonds.

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