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. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. What is the current price of the bonds? (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.)

Answer 1

Lance Whittingham IV is willing to purchase a bond with values,

Face value = $1000

coupon rate = 7% annual,

coupon = 7% of 1000 = $70

years to maturity = 16 years

The current yield to maturity on similar bonds is 11 percent.

So, YTM of this bond = 11%

a). Using financial calculator to solve for price, use following values:

FV = 1000

PMT = 70

N = 16

I/Y = 11

compute for PV, we get PV = -704.83

So, price of the bond now = $704.83

b). at maturity price of the bond will equal to $1000.

So percentage change in price = (1000-704.83)/704.83 = 41.88%

So price will increase by 41.88%