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Fm doubt- finanacing dicisions

harish ragav (student-IPCC) (407 Points)

21 December 2013

Reserve bank of india proposing to sell 5 year bond of rs 5000 @ 8 % interest p.a.the bond amount will be amortized equally over the life of the bond. what is the bond's present value for an investor if he expects a minimum rate of return of 6% ?

i didn't understand the question in the correct manner can any one pls explain the question briefly.

for ref:- ipcc gr1 FM stud mat page 4.7.

thanks in advance.

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Neeta Kishorbhai Jethmalani (Article assistant) (53 Points)
Replied 21 December 2013

Hello,Harish "Reserve bank of india proposing to sell 5 year bond of rs 5000" means that RBI wants to issue a bond having face value of Rs 5000 for a term period of 5 years @ 8% .Further it is said that "the bond amount will be amortized equally over the life of the bond" that means the bond amount will be redeemed equally over the life of bond by RBI.Suppose as of now we are standing at 0 year end and so Rs 1000 will be redeemed in Year 1, Rs 1000 in Year 2 and so on.... upto 5th Year end.This means that we are told in the question that instead of one redemption at the end of 5th year, RBI is redeeming equally the bond amount over the life of bond (i.e 5 Years) and further it is told that the investors required rate of return is 6% which means that the cash flows will be discounted at 6% and the interest on bond will be received @ 8%.Now, the question asks to find out the present value of bond which can be answered by preparing cash flow series for a period of 5 years. Hope you get IDEA !!