In: Finance
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 4 percent annual interest and has 18
years remaining to maturity. The current yield to maturity on
similar bonds is 12 percent.
a. What is the current price of the bonds? 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.)
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.)
Solution: | ||||||
a) | FV | $1000 | ||||
Annual Interest | 4% | |||||
Interest =$1000*4% | 40 | |||||
Term | 18 Years | |||||
Yield to Maturity | 12% | |||||
Appendix D | ||||||
Present Value of Interest Payments | ||||||
1/1.12^1 | 0.892857143 | |||||
1/1.12^2 | 0.797193878 | |||||
1/1.12^3 | 0.711780248 | |||||
1/1.12^4 | 0.635518078 | |||||
1/1.12^5 | 0.567426856 | |||||
1/1.12^6 | 0.506631121 | |||||
1/1.12^7 | 0.452349215 | |||||
1/1.12^8 | 0.403883228 | |||||
1/1.12^9 | 0.360610025 | |||||
1/1.12^10 | 0.321973237 | |||||
1/1.12^11 | 0.287476104 | |||||
1/1.12^12 | 0.256675093 | |||||
1/1.12^13 | 0.22917419 | |||||
1/1.12^14 | 0.204619813 | |||||
1/1.12^15 | 0.182696261 | |||||
1/1.12^16 | 0.163121662 | |||||
1/1.12^17 | 0.145644341 | |||||
1/1.12^18 | 0.13003959 | |||||
Sum | 7.249670082 | |||||
PV of interest payments = Interest amount * Total of Discounting Factor | ||||||
$40*7.249670082 | ||||||
$289.99 | ||||||
Appendix B | ||||||
PV of principal Payments at Maturity | ||||||
PV of principal Payments at Maturity = Maturity Value * Discounting Factor of 18 Period | ||||||
$1000*0.13003959 | ||||||
$130.04 | ||||||
Current Price of bond = $289.99+$130.04 | ||||||
Current Price of bond = | $420.03 | |||||
We can also calculate the Current price of bond by | ||||||
Using PV Function in excel we will calculate the Current Price of bond | ||||||
PV(12%,18,40,1000) | ||||||
$420.03 | ||||||
b) | Maturity Value | $1000 | ||||
Current Price of Bond | $420.03 | |||||
Dollar increase in Price | $579.97 | |||||
Percent Increase = Increase in Price /Current Price *100 | ||||||
$579.97/$420.03*100 | ||||||
138.08 | % | |||||
The bond would increase by 138.08% | ||||||