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Martin Shipping Lines issued bonds ten years ago at $2,700 per bond. The bonds had a...

Martin Shipping Lines issued bonds ten years ago at $2,700 per bond. The bonds had a 30-year life when issued, with semiannual payments at the then annual rate of 10 percent. This return was in line with required returns by bondholders at that point, as described below:

    

  Real rate of return 2 %
  Inflation premium 4
  Risk premium 4
  Total return 10 %

    

Assume that today the inflation premium is only 2 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds.

      

Compute the new price of the bond.

Solutions

Expert Solution

                                             Martin Shipping Lines      

First compute the new required rate of return (yield to maturity).

Real rate of return                                                                2%

Inflation premium                                                                2%

Risk premium                                                                         4%

Total return                                                                             8%

Then use this value to find the price of the bond.

Present Value of Interest Payments

PVA = A × PVIFA (n = 20, i = 8%)                Appendix D

PVA = $270 × 9.818 = $2,650.86

Present Value of Principal Payment at Maturity

PV = FV × PVIF (n = 20, i = 8%)    Appendix B

PV = $2,700 × .215 = $580.5

The new price of the bond = $2,650.86+ $580.5 = $3,231.36

jeff jeffy answered 6 months ago
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