Question

Lance Whittingham IV specializes in buying deep discount bonds. These represent bonds that are trading at well below par value. He has his eye on a bond issued by the Leisure Time Corporation. The $1,000 par value bond pays 7 percent annual interest and has 16 years remaining to maturity. The current yield to maturity on similar bonds is 15 percent.
  
a. What is the current price of the bonds? Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
  

   
b. By what percent will the price of the bonds increase between now and maturity? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
  

  

eBook & Resources

eBook: Valuation of Bonds

Answer 1

Given,

FV = 1000

PMT = 0.07*1000 = 70

N = 16

I = 0.15

Input these values in financial calculator, compute, CPT PV = 523.66

Using formula:

	Rate	0.1500
Year(n)	Cashflow (A)	Discount rate = 1/(1+r)^(n)	Present Value = A*discount rate
1	70	0.86956522	60.86956522
2	70	0.75614367	52.93005671
3	70	0.65751623	46.02613627
4	70	0.57175325	40.02272719
5	70	0.49717674	34.80237147
6	70	0.4323276	30.26293171
7	70	0.37593704	26.31559279
8	70	0.32690177	22.88312417
9	70	0.28426241	19.89836884
10	70	0.24718471	17.30292943
11	70	0.21494322	15.04602559
12	70	0.18690715	13.08350051
13	70	0.16252796	11.37695697
14	70	0.14132866	9.893006059
15	70	0.12289449	8.602613964
16	1070	0.10686477	114.3453036
		NPV	523.6612105

b.

At maturity, bond price = par value

Bond price = 1000

Increase = 1000 - 523.66 = 476.34

% increase = 476.34/523.66 = 0.9096 = 90.96%