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PLEASE SOLVE THIS SFM QUESTION

CA. A. K. GUPTA (HOD (Accounts Dept)) (1426 Points)

19 April 2011

MP Ltd. issued a new series of bonds on January 1, 2000. The bonds were sold at par

(Rs.1,000), having a coupon rate 10% p.a. and mature on 31st December, 2015. Couponpayments are made semiannually on June 30th and December 31st each year. Assumethat you purchased an outstanding MP Ltd. Bond on 1st March, 2008 when the going interest rate was 12%.

Required:

(i) What amount you should pay to complete the transaction? Of that amount how

much should be accrued interest and how much would represent bonds basic value.

PLEASE ANSWER AS SOON AS POSSIBLE( WITH FULL DETAIL)

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(Guest)

Assumption: Current interest rate on 1st January 2008 = 12% p.a. semiannually.

Market value on 1st January 2008 ; 50(9.712) + 1050(0.394) = 899.30

Market value on 1st March,2008 : 899.30(1.02) = 917.29

Payment for complete transaction : 917.29

Interest accrued = 1000 x 0.10 x (2/12) = 16.67

Bond’s basic value = 917.29 – 16.67 = 900.62

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CA Nagendra (CA) (1788 Points)
Replied 20 April 2011

Originally posted by : vinnzz
	Assumption: Current interest rate on 1st January 2008 = 12% p.a. semiannually. Market value on 1st January 2008 ; 50(9.712) + 1050(0.394) = 899.30 Market value on 1st March,2008 : 899.30(1.02) = 917.29 Payment for complete transaction : 917.29 Interest accrued = 1000 x 0.10 x (2/12) = 16.67 Bond’s basic value = 917.29 – 16.67 = 900.62

Your solution is absolutly correct.

This question was asked in NOV-2007 for 6 marks. Suggested answer for this question is 100% wrong. so do not see suggested answer. The solution of Vinnzz is correct solution.

Further i would like to clarify the assumption used in the above solution.

We assumed that the given rate as on 1.March.2008 is compounded continuously.

Reason being that if invester receive interest at every six month time then this receipt is available for investment at the time of receipt. it means invester get interest on interest at every six month. which mean compunded semiannualy.

Why we calculated value as on 1 jan 2008 first and then as on 1 March 2008? why not directly as on 1 march 2008?

When we assumed interest rate is compunded semi annualy then one period get for 6 month. when we discount future inflow with the interest rate of 6 month then present value goes directly 6 month back. so we can not calculate value of bond as on 1 march 2008 directly. because 6 month period end on 1 january and on 1 october.

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CA. A. K. GUPTA (HOD (Accounts Dept)) (1426 Points)
Replied 20 April 2011

THANK YOU VERY MUCH SIR(CA Nagendra & vinnzz)

actually i was thinking to solve this question in the above menner as told by you, but in suggested answer of icai & book of Ashish Kalra gives different views & different solutions, but both answers are wrong.

thanks again

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