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 5 percent annual interest and has 14 years remaining to maturity. The current yield to maturity on similar bonds is 15 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.)
  

Answer 1

Answer No. a

Given

Par Value = $ 1000 ; Interest Rate = 5% annually = $50 per year (1000*5/100) ; YTM = 15%

Year	Annual Interest	PV @ 15%	PV*Annual Interest
1	50	0.870	43.47826087
2	50	0.756	37.80718336
3	50	0.658	32.87581162
4	50	0.572	28.58766228
5	50	0.497	24.85883676
6	50	0.432	21.6163798
7	50	0.376	18.796852
8	50	0.327	16.34508869
9	50	0.284	14.2131206
10	50	0.247	12.35923531
11	50	0.215	10.74716114
12	50	0.187	9.345357509
13	50	0.163	8.126397834
14	50	0.141	7.066432899
		Total of PV* Annual Interest >>	286.2237807
		Present Value of par value>>>	141.328658
		Current Price of the bond>>>>	427.55

Important thing to note here is that

• The Interest payments of $50 will be constant
• The formula for present value used here is 1/(1+.15)^n where n is the number of year
• The present value of the par value of bond has been found out by 1000*0.141
• The current price of the bond has been found out by adding the Total of PV of annual interest and the present value of the par value of the bond which has come out to be $427.55

Answer b Increase in the price of the bond = 1000-427.55 = 572.45

Percentage increase in the price of the bond = Increase in price / Current Price * 100 = 527.45 /427.55 = 133.89%