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 6 percent annual interest and has 15 years remaining to maturity. The current yield to maturity on similar bonds is 15 percent. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. What is the current price of the bonds? (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)

	Current price of the bond

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.)

	Price increases by %

Answer 1

a. Method 1÷

Price of bond = Interest amount × PVAF× (Rate, years) + Par value/(1 + rate)^years

OR

Method 2÷

Price of bond = Interest /(1+rate)¹ + Interest/(1+ rate)² + Interest/(1 + rate)³ + .................... + Interest/(1 + rate)ⁿ + Par value/(1 + rate)ⁿ

Where n= number of years to maturity. In this question, n = 15 years.

We will use the method 1 to calculate the price of the bond.

Interest amount = 1,000 × 6% = $60

Rate = 15%

Years = 15

Price of bond = 60 × PVAF ×(15%,15) + 1,000/(1 + 15%)¹⁵

=60 × 5.84737009827 + 1,000 × 0.12289448517

=350.842205896 + 122.89448517

=473.736691066

=$473.74

The current price of the bond is $ 473.74

b. Percentage increase in the price of bond between now and maturity =

At the time of maturity, the price of the bond will be at par value i.e. $ 1,000

Current price =$473.74

Price at maturity =$ 1,000

So increase in price of bond =

=(Maturity price - Current price)/Current price × 100

= (1,000 - 473.74)/473.74 ×100

= 111.086249841

= 111.09 %

Summary

a. Current price of bond =$ 473.74

b. Price increases by % = 111.09%

Note ÷

Only final answers have been rounded to 2 decimals and intermediate figures have not been rounded off.