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 $1,000 par value bond pays 6 percent annual interest and has 15 years remaining to maturity. The current yield to maturity on similar bonds is 14 percent.
(a) What is the current price of the bonds? Use Appendix B and Appendix D. (Round "PV Factor" to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the "$" sign in your response.) Current price ________ $
(b) By what percent will the price of the bonds increase between now and maturity? (Round "PV Factor" to 3 decimal places, intermediate and final answers to 2 decimal places. Omit the "%" sign in your response.) Price increases by __________ %

Answer 1

Answer:

a. $508.63

b. 96.6%

Explanation:

a. Bond price = Present value of coupon payments + Present value of par value

Coupon = 6% * 1,000

= $60

Bond price = 60 * (( 1 - (1 + 14%)⁻¹⁵) / 14%) + 1,000 / ( 1 + 14%)¹⁵

= 508.62656

= $508.63

b. At maturity, the bond will return back to its par value of $1,000.

= (1,000 - 508.63) / 508.63

= 96.6%