Question

# A 25-year, \$1,000 par value bond has an 8.5% annual coupon. The bond currently sells for...

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?

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

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