Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bond
ID: 2567285 • Letter: T
Question
Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 13 percent. This return was in line with the required returns by bondholders at that point as described below:
Real rate of return = 4%
Inflation premium = 5
Risk premium = 4
Total return = 13%
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity. Compute the new price of the bond.
(Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
Real rate of return = 4%
Inflation premium = 5
Risk premium = 4
Total return = 13%
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity. Compute the new price of the bond.
(Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.)
Problem 10-13 Effect of yield to maturity on bond price [LO10-3] Tom Cruise Lines Inc. issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 13 percent. This return was in line with the required returns by bondholders at that point as described below 4% Real rate of return Inflation premium Risk premium Total retunn 13% Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity Compute the new price of the bond. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. (Do not round intermediate calculations. Round your final answer to 2 decimal places. Assume interest payments are annual.) New price of the bondExplanation / Answer
Required Return after 5 year = Real rate of return + Inflation premium + Risk premium
= 3 + 3 + 4
=10%
No of year left to maturity = 20 years
Annual Interest payment = 13% * $1000 = $130
Face value of Bond = $1000
Present Value of Interest Payments :-
PV(a) = A * PV(IFA)(n=20, i = 10%)
= $130 * 8.514
= $1106.82
Present Value of Principal Payment at Maturity :-
PV = FV * PV(IF)(n=20, i=10%)
= $1000 * 0.149
= $149
New Price of Bonds = $1106.82 + $149 = $1255.82 or $1256