Lance Whittingham IV specializes in buying deep discount bonds. These represent

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 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.)

Explanation / Answer

Fair Value (FV) = $1000
PMT = 7% * 1000 =$70
Number of years (N) = 16 years
Rate (I) = 11%

a.    Current price of the bonds
Present Value of Interest Payments
PVA = A × PVIFA (n = 16, i = 11%) [Appendix D]   
PVA = $70 × 7.379 = $516.53
Present Value of Principal Payment at Maturity [Appendix B]
PV = FV × PVIF (n = 16, i = 11%)
PV = $1,000 × .188 = $188
Therefore, Present Value of Interest Payments $516.53
Add: Present Value of Principal Payment at Maturity $188.00
Current Price of the bond                                          $704.53

b. Percentage increase in maturity:
Maturity Value             :      $1000
Current Price                :    - $704.53
Increase in dollar          :      $295.47

Therefore, percentage increase = increase in dollar / current price = $295.47 / $704.53 = 41.94%

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