Question

Ron Rhodes calls his broker to inquire about purchasing a bond of Golden Years Recreation Corporation. His broker quotes a price of $1,180. Ron is concerned that the bond might be overpriced based on the facts involved. The $1,000 par value bond pays 10 percent annual interest payable semiannually, and has 20 years remaining until maturity. The current yield to maturity on similar bonds is 8 percent.   

a. Compute the new price of the bond. (Use a Financial calculator to arrive at the answers. Do not round intermediate calculations. Round the final answer to 2 decimal places.)

New price of the bond           $

b. Do you think the bond is overpriced?

• No

• Yes

Answer 1

Broker Quote Price = $1,180

Par Value = $1,000

Semi-annual Interest Payment =$1,000*10%*1/2

=$50

No of years to maturity = 20 years

n = 20 years*2 = 40

Semi-annual YTM = 8%/2 = 4%

Calculating the New Price of the Bond:-

Price = $989.64 + $208.29

Price = $1197.93

So, New Price of Bond is $1,197.93

b). New Price as per Market YTM = $ 1,197.93

Price quoted by broker = $1,180

As Price quoted by broker is less than the Price as Market YTM. Thus, Bond is Underpriced.

Hence, No