Question

A 25-year, $1,000 par value bond has an 8.5% annual coupon. The bond currently sells for $875. If the yield to maturity remains at its current rate, what will the price be 5 years from now?

Answer 1

Step 1: Calculation of Yield to Maturity (YTM)

Yield to Maturity (YTM) can be calculated as

( interest per annum + average other cost per annum ) / average fund employed

Where

average other cost per annum = (Redemption price - current market price)/remaining life

= (1000 - 875) / 25

= 5

average fund employed = (Redemption price + current market price)/2

= (1000+875)/2

=937.5

Yield to Maturity (YTM) = (85 + 5) / 937.5

= .096

= 9.6%

Step 2: Calculation of price be 5 years from now

The value of bond is the present value of the expected future cashflows from the bond,discounted at Yield to Maturity(YTM).

Year	Cash flow	PVAF/[email protected]%	Present Value (Cashflow*PVAF/PVF)
1-20	85	8.7513*	743.86
20	1000	0.1599**	159.90

Current Market Price of Bonds = $903.76 (743.86+159.9)

*PVAF = (1-(1.096)^^-20)/.096 = 8.7513

**PVF = 1 / (1.096)²⁰ = 0.1599