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Chapter 4: Q17BP (page 324)

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 4 percent annual interest and has 18 years remaining to maturity. The current yield to maturity on similar bonds is 14 percent.

a. What is the current price of the bonds?

b. By what percent will the price of the bonds increase between now and maturity?

c. What is the annual compound rate of growth in the value of the bonds? (An approximate answer is acceptable.)

Short Answer

Expert verified
  1. Current price of bond of the company is $353.24
  2. Percentage increasein the price of the bonds increase between now and maturityis 183.09%
  3. The annual compound rate of growth is between 5.95%

Step by step solution

01

Current price of the bonds-

Coupon=ParValue脳CouponRate=$1,000脳4%=$40

  • Par value of bond (P) is $1,000.
  • Yield to maturity (r) is 14%.
  • Years to maturity (n) is 18.
  • Bondprice=Coupon脳[1-11+rn]r+P(1+r)n=$40脳[1-11+0.1418]0.13+$1,000(1+0.14)18=$40脳6.467+94.56=$353.24
02

Percentage increase in the price of the bonds increase between now and maturity

Maturity value

$1,000

Less: Current price

$353.24

Increase value

$646.76

Percentageincrease=Increasevaluecurrentprice=$646.76$353.24=183.09%

03

Annual compound rate of growth- 

AnnualGrowthRate=(EndingValuePurchasePrice)1/n-1=($1,000$353.24)1/18-1=1.0595-1=5.95%

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Most popular questions from this chapter

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.

Go to Table 10-1, which is based on bonds paying 10 percent interest for 20 years. Assume interest rates in the market (yield to maturity) decline from 11 percent to 8 percent:

a. What is the bond price at 11 percent?

b. What is the bond price at 8 percent?

c. What would be your percentage return on investment if you bought when rates were 11 percent and sold when rates were 8 percent?

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�?

Question: Assume $65,000 is going to be invested in each of the following assets. Using Tables 12-11 and 12-12, indicate the dollar amount of the first year鈥檚 depreciation

a. Office furniture.

b. Automobile.

c. Electric and gas utility property.

d. Sewage treatment plant.

Using Table 10-2:

a. Assume the interest rate in the market (yield to maturity) goes down to 8 percent for the 10 percent bonds. Using column 2, indicate what the bond price will be with a 10-year, a 15-year, and a 20-year time period.

b. Assume the interest rate in the market (yield to maturity) goes up to 12 percent for the 10 percent bonds. Using column 3, indicate what the bond price will be with a 10-year, a 15-year, and a 20-year period.

c. Based on the information in part a, if you think interest rates in the market are going down, which bond would you choose to own?

d. Based on information in part b, if you think interest rates in the market are going up, which bond would you choose to own?
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