Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bond

Question

Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 15 percent. This return was in line with the required returns by bondholders at that point as described below: Real rate of return: 5% Inflation premium: 5 Risk premium: 5 Total return: 15% Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity. Compute the new price of the bond. 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.)

Explanation / Answer

When the bond was issued, given it was issued at par so in that case, copon rate must be equal to ytm which is 15%

Hence, coupons=1000*15%=150

ytm now=5+5+3=13%

Price now=150/1.13+150/1.13^2...........150/1.13^20+1000/1.13^20

=150/1.13*(1-1/1.13^20)/(1-1/1.13)+1000/1.13^20

=150/0.13*(1-1/1.13^20)+1000/1.13^20

=1140.495

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