Tom Cruise Lines Inc. issued bonds five years ago at $1,000 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:
Real rate of return | 4 | % |
Inflation premium | 5 | |
Risk premium | 4 | |
Total return | 13 | % |
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity.
Compute the new price of the bond. 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.)
The Revised Yield to Maturity of the Bond
The Revised Yield to Maturity of the Bond = Real rate of return + Revised Inflation premium + Risk premium
= 4.00% + 3.00% + 4.00%
= 11.00%
New Price of the Bond
Variables |
Financial Calculator Keys |
Figure |
Par Value/Face Value of the Bond [$1,000] |
FV |
1,000 |
Coupon Amount [$1,000 x 13.00%] |
PMT |
130 |
Market Interest Rate or Yield to maturity on the Bond [11.00%] |
1/Y |
11.00 |
Maturity Period/Time to Maturity [20 Years] |
N |
20 |
Bond 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) = $1,159.27.
“Hence, the New Price of the Bond will be $1,159.27”
Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the...
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