Question

Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 30-year life when issued and the annual interest payment was then 15 percent. This return was in line with the required returns by bondholders at that point as described below:
  

Real rate of return	5	%
Inflation premium	5
Risk premium	5
Total return	15	%

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 25 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.)

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 +   Risk premium

= 5.00% + 3.00% + 5.00%

= 13.00%

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
Face Value [-$1,000]	FV	-1,000
Coupon Amount [$1,000 x 15%]	PMT	150
Market Interest Rate or Required Rate of Return [13.00%]	1/Y	13
Time to Maturity [30 Years – 5 Years]	N	25
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 = $1,146.60.

“Therefore, the New Price of the Bond will be $1,146.60”