Question

3) Microform, Inc. issued bonds 10 years ago at $1,000 per bond. These bonds had a 15 year life when issues and the annual interest rate / coupon on the bonds was then 12%. This return was in line with the required returns by bondholders at that point as described next: Real Rate of Return = 4% Inflation Premium = 4% Risk Premium = 4% Total Return = 12% Assume that 10 years later the inflation premium is only 2% and the Risk Premium is now 8%. The Real Rate of Return remained at 4%. The new Total Return (yield) required rate remaining until maturity, would compute to what new price on the bond?

Answer 1

	Par value		1000
	Coupon rate		12%
	Years to maturity	(15-10 )	5
	New Required Return =	2+4+8 =	14%
	Price of new bond =		PV of cash flows discounted at Required rate
	Year	Cashflow	PV factor @ 14%	PV of cashflow
	1	120	0.877193	105.2632
	2	120	0.769468	92.3361
	3	120	0.674972	80.99658
	4	120	0.59208	71.04963
	5	1120	0.519369	581.6929
				931.3384
	New price =			931.3384