Media Bias Inc. issued bonds 10 years ago at $1,000 per bond. These bonds had a
ID: 2812206 • Letter: M
Question
Media Bias Inc. issued bonds 10 years ago at $1,000 per bond. These bonds had a 30-year life when issued and the annual interest payment was then 14 percent. This return was in line with the required returns by bondholders at that point in time as described below Real rate of return Inflation premium Risk premium 4% Total return 14% Assume that 10 years later, due to good publicity, the risk premium is now 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
The new price of the bond will be equal to the total present value of the bond's remaining cash flows (coupon payments and redeemed par value at maturity). However, the required return (discount rate) will change owing to the bond's better prospects and lowering of its risk premium.
New Required Return = Real Rate of Return + Inflation Premium + New Risk Premium = 4 + 5 + 3 = 12 %
Further, as the bonds were issued at $ 1000 per bond (which is the bond's par value), the annual coupon rate will be equal to the bond's required rate of return at issue.
Annual Coupon Rate = 14 %
Annual Coupon Payment = 0.14 x 1000 = $ 140
Remaining Bond Tenure = 20 years
Therefore, New Bond Price = P = 140 x (1/0.12) x [1-{1/(1.12)^(20)}] + 1000 / (1.12)^(20) = $ 1149.38 approximately.