Question

You have been asked to estimate the value of a 10-year bond with a coupon that will be low initially but it is expected to grow later in the bond’s life. The coupon is expected to be 5% of the face value of the bond (which is $ 1000) for the first 5 years, and will increase by 1% every year for the next 5 years; the coupon rate will be 6% in year 6, 7% in year 7, 8% in year 8, 9% in year 9 and 10% in year 10. Estimate the value of this bond.