Lance Whittingham IV specializes in buying deep discount bonds. These represent
ID: 2812110 • 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 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.)
Explanation / Answer
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%
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