Lance Whittingham IV specializes in buying deep discount bonds. These represent
ID: 2681959 • Letter: L
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 $1,000 par value bond pays 7 percent annual interest and has 16 years remaining to maturity. The current yield to maturity on similar bonds is 11 percent.(a)
What is the current price of the bonds? Use Appendix B and Appendix D. (Round "PV Factor" to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the "$" sign in your response.)
Current price $
(b)
By what percent will the price of the bonds increase between now and maturity? (Round "PV Factor" to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.)
Price increases by %
Explanation / Answer
Lance Whittingham IV
a. Current price of the bonds
Present Value of Interest Payments
PVA = A × PVIFA (n = 16, i = 10%)
PVA = $40 × 7.824 = $312.96
Present Value of Principal Payment at Maturity
PV = FV × PVIF (n = 16, i = 10%)
PV = $1,000 × .218 = $218
$312.96
218.00
$530.96
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b. Percent increase at maturity
Maturity Value $1,000.00
Current price – 530.96
Dollar increase $ 469.04
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c. Compound rate of growth
The bond will grow by 88.34 percent over 16 years. Using Appendix A, the future value of $1 and the interest factor of 1.883 (1+.8834),
the growth rate is between 4 and 5 percent
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