Probably a little late in the game to be asking questions like this but… I’m doing practice problems and on page 480 of volume 5, question 2 says:
A 5-year amortizing security with a par value of $100,000 and a coupon of 6.4% has an expected cash flow of 23,998.55 per year. Cash flow includes interest and principal payment. What is the value of this security (assuming no prepayments) at a discount rate of 7.8%?
My approach was to use $100,000 as the future value, the $23,998.55 as the pmt, set N=5 and I/Y to 7.8 and compute the PV. But this is wrong! The book says the answer is the present value of 5 years of cash flows at $23,998.55 (one discounted back one year at 7.8%, one discounted back two years, etc.)
My questions: where does the par value and coupon payment come into the equation? Are they ignored for this type of security?
The value of an investment is the present value of its future cash flows, discounted at an appropriate rate of interest.
For this security, you’re told that the cash flows are $23,999 per year; those are the cash flows that you discount at 7.8%. (And you should get $96,326.)
The par value and interest are embodied in the $23,999 payments; you can separate them if you want: it’s a fun exercise.