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 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?

Answer 1

Answer a.

Par Value = $1,000

Annual Coupon Rate = 7%
Annual Coupon = 7%*$1,000
Annual Coupon = $70

Time to Maturity = 16 years
Yield to Maturity = 12%

Current Price = $70 * PVIFA(12%, 16) + $1,000 * PVIF(12%, 16)
Current Price = $70 * (1 - (1/1.12)^16) / 0.12 + $1,000 / 1.12^16
Current Price = $70 * 6.97399 + $1,000 * 0.16312
Current Price = $651.30

So, current price of bond is $651.30

Answer b.

Percentage Increase in Price = (Maturity Price - Current Price) / Current Price
Percentage Increase in Price = ($1,000 - $651.30) / $651.30
Percentage Increase in Price = 0.5354
Percentage Increase in Price = 53.54%