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Chapter 4: 10BP (page 322)

Using Table 10-1, assume interest rates in the market (yield to maturity) are 14 percent for 20 years on a bond paying 10 percent.

a. What is the price of the bond?

b. Assume five years have passed and interest rates in the market have gone down to 12 percent. Now, using Table 10-2 for 15 years, what is the price of the bond?

c. What would your percentage return be if you bought the bonds when interest rates in the market were 14 percent for 20 years and sold them 5 years later when interest rates were 12 percent?

Short Answer

Expert verified

a. Bond price for 14% yield to maturity for 20 years is $735.07

b. Bond price for 12 % yield to maturity for 15 years is $863.78

c. Percentage return on Investment is 17.51%

Step by step solution

01

a. The price of the bond

  • Par value of bond (P) is $1,000.
  • Yield to maturity (r) is 14%.
  • Years to maturity (n) is 20.
  • Coupon rate (CR) is 10%.

  • PresentValueofPrincipal=P(1+r)nPresentValueofCoupon=P脳CR脳[1-11+rn]r

    Yield to maturity

    PV of Coupons

    PV of Principal

    Bond Price

    14%

    $662.31

    +

    $72.76

    =

    $735.07

02

b. The price of the bond:

  • Par value of bond (P) is $1,000.
  • Yield to maturity (r) is 12%.
  • Years to maturity (n) is 15.
  • Coupon rate (CR) is 10%.

Bondprice=P脳CR脳[1-11+rn]r+P(1+r)n

Time Period in Years to Maturity

Bond Price with 12% Yield to Maturity

15

$863.78

03

c. Computing percentage return -

Percentagereturn=Bondpriceat12%-Bondpriceat14%Bondpriceat14%脳100=$863.78-$735.07$735.07脳100=17.51%

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Most popular questions from this chapter

Question: Phil Goode will receive $175,000 in 50 years. His friends are very jealous of him. If the funds are discounted back at a rate of 14 percent, what is the present value of his future 鈥減ot of gold鈥�?

Tim Trepid is highly risk-averse while Mike Macho actually enjoys taking a risk.

a. Which one of the four investments should Tim choose? Compute coefficients of variation to help you in your choice.

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Buy stocks ..................................... \( 9,140 \) 6,140

Buy bonds ..................................... 7,680 2,560

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Hooper Chemical Company, a major chemical firm that uses such raw materials as carbon and petroleum as part of its production process, is examining a plastics firm to add to its operations. Before the acquisition, the normal expected outcomes for the firm were as follows:

Outcomes (\( millions) Probability

Recession .............................. \)20 0.30

Normal economy ................... 40 0.40

Strong economy .................... 60 0.30

After the acquisition, the expected outcomes for the firm would be:

Outcomes (\( millions) Probability

Recession .............................. \) 10 0.3

Normal economy ................... 40 0.4

Strong economy .................... 80 0.3

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b. After the acquisition, these values are as follows:

Expected value .............................................. 43.0 (\( millions)

Standard deviation ........................................ 27.2 (\) millions)

Coefficient of variation ................................... 0.633

Comment on whether this acquisition appears desirable to you.

c. Do you think the firm鈥檚 stock price is likely to go up as a result of this acquisition?

d. If the firm were interested in reducing its risk exposure, which of the following three industries would you advise it to consider for an acquisition?

Briefly comment on your answer.

(1) Chemical company

(2) Oil company

(3) Computer company

Larry Davis borrows $80,000 at 14 percent interest toward the purchase of a home. His mortgage is for 25 years.

a.How much will his annual payments be? (Although home payments are usually on a monthly basis, we shall do our analysis on an annual basis for ease of computation. We will get a reasonably accurate answer.)

b.How much interest will he pay over the life of the loan?

c.How much should he be willing to pay to get out of a 14 percent mortgage and into a 10 percent mortgage with 25 years remaining on the mortgage?

Assume current interest rates are 10 percent. Carefully consider the timeb value of money. Disregard taxes.

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