Question

Tom Cruise Lines Inc. Issued bonds five years ago at $1000 per bond. These bonds had a 25- year life when issued and the annual interest payment was then 13 percent. This return was in line with the required returns by bondholders at that point as described below 5 l rate of inflation premiun Risk preniun Total returs 139 eBlook Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required retum for yield to maturity) of the bonds. The bonds have 20 years remsining until maturity Compute the new price of the bond. Use Appendix 8 and Appendix D for an approximate answer but caculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 d Assume interest payments are annual.) price of the bond

Answer 1

Answer

Yield to maturity = Real rate of return + Inflation premium + Risk premium

                                 = 4% + 3% + 4%

                                 = 11%

				Figures in $
Year	Interest payment	Redemption price	Cash flow	Disc Rate : 11%	Present value
	A	B	C	D
			A+B		C*D
	1000*0.13
1	130		130	0.90	117.12
2	130		130	0.81	105.51
3	130		130	0.73	95.05
4	130		130	0.66	85.64
5	130		130	0.59	77.15
6	130		130	0.53	69.50
7	130		130	0.48	62.62
8	130		130	0.43	56.41
9	130		130	0.39	50.82
10	130		130	0.35	45.78
11	130		130	0.32	41.25
12	130		130	0.29	37.16
13	130		130	0.26	33.48
14	130		130	0.23	30.16
15	130		130	0.21	27.17
16	130		130	0.19	24.48
17	130		130	0.17	22.05
18	130		130	0.15	19.87
19	130		130	0.14	17.90
20	130	1000	1130	0.12	140.16
Present value					1159.27

Answer : New price of the bond is $ 1159.27