Question

The Vinny Cartier Company issued bonds at $1,000 per bond. The bonds had a 30-year life when issued, with semiannual payments at the then annual rate of 14 percent. This return was in line with required returns by bondholders at that point, as described below:

Real rate of return 5%

Inflation premium 5

Risk premium 4

Total return 14% Assume that ten years later the inflation premium is 3 percent, the risk premium has declined to 3 percent and both are appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity.

Answer 1

The Revised Yield to Maturity of the Bond

The Revised Yield to Maturity of the Bond =   Real rate of return + Revised Inflation premium + Revised Risk premium

= 5.00% + 3.00% + 3.00%

= 11.00%

New Price of the Bond

· The Price of the Bond is the Present Value of the Coupon Payments plus the Present Value of the Face Value/Par Value.

· The Price of the Bond is normally calculated either by using EXCEL Functions or by using Financial Calculator.

· Here, the calculation of the Bond Price using financial calculator is as follows

Variables	Financial Calculator Keys	Figures
Par Value/Face Value of the Treasury Note [$1,000,]	FV	1,000
Coupon Amount [$1,000 x 14.00% x ½]	PMT	70
Market Interest Rate or Yield to maturity on the Bond [11.00% x ½]	1/Y	5.50
Maturity Period/Time to Maturity [20 Years x 2]	N	40
Treasury Note Price	PV	?

Here, we need to set the above key variables into the financial calculator to find out the Price of the Bond. After entering the above keys in the financial calculator, we get the Price of the Bond (PV) = $1,240.69.

“Hence, the New Price of the Bond will be $1,240.69”