Problem 7-15 Bond valuation Bond X is noncallable and has 20 years to maturity,
ID: 2647098 • Letter: P
Question
Problem 7-15
Bond valuation
Bond X is noncallable and has 20 years to maturity, a 11% annual coupon, and a $1,000 par value. Your required return on Bond X is 8%; and if you buy it, you plan to hold it for 5 years. You (and the market) have expectations that in 5, years the yield to maturity on a 15-year bond with similar risk will be 7.5%. How much should you be willing to pay for Bond X today? (Hint: You will need to know how much the bond will be worth at the end of 5 years.) Round your answer to the nearest cent.
Problem 7-18
Yield to maturity and yield to call
Kaufman Enterprises has bonds outstanding with a $1,000 face value and 10 years left until maturity. They have an 12% annual coupon payment, and their current price is $1,175. The bonds may be called in 5 years at 109% of face value (Call price = $1,090).
What is the yield to maturity? Round your answer to two decimal places.
%
What is the yield to call if they are called in 5 years? Round your answer to two decimal places.
%
Explanation / Answer
Answer:
Present value of the 15 year similar bond at the end of year 5
= Present value of interest payments + present value of terminal value
= (Interest * PVAF (15 Years, 7.5%)) + ( Par value * PVF (15th Year, 7.5%))
= (1000*11% * 8.82712) + (1000*0.33797)
= 970.98 + 337.97
= $1308.95
Hence we can say that if we hold the bond for 5 years then the price at the end of the year 5 shall be= $1308.95
Now we shall calculate the price of the bond at 8% required return for 5 years = Present value of interest payments + present value of terminal value
= (Interest * PVAF (5 Years, 8%)) + ($1308.95 * PVF (5th Year, 8%))
=(1000*11% * 3.99271) + (1308.95 * 0.68058)
= 439.20 + 890.85
= $1330.05
Hence we should be willing to pay $1330.05 for Bond X today.