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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

If, as an investor, you had a choice of daily, monthly, or quarterly compounding, which would you choose? Why?

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What two components make up the required rate of return on common stock?

Jim Busby calls his broker to inquire about purchasing a bond of Disk Storage Systems. His broker quotes a price of \(1,180. Jim is concerned that the bond might be overpriced based on the facts involved. The \)1,000 par value bond pays 14 percent interest, and it has 25 years remaining until maturity. The current yield to maturity on similar bonds is 12 percent. Compute the new price of the bond and comment on whether you think it is overpriced in the marketplace.

Question:Surgical Supplies Corporation paid a dividend of $1.12 per share over the last 12 months. The dividend is expected to grow at a rate of 2.5 percent over the next three years (supernormal growth). It will then grow at a normal, constant rate of 7 percent for the foreseeable future. The required rate of return is 12 percent (this will also serve as the discount rate).

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P3 = D4/ (Ke - g)

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