A $1,000 par value bond was issued 20 years ago at a 12 percent coupon rate. It
ID: 2620494 • Letter: A
Question
A $1,000 par value bond was issued 20 years ago at a 12 percent coupon rate. It currently has 15 years remaining to maturity. Interest rates on similar obligations are now 8 percent. Assume Ms. Bright bought the bond three years ago when it had a price of $1,070. Further assume Ms. Bright paid 40 percent of the purchase price in cash and borrowed the rest (known as buying on margin). She used the interest payments from the bond to cover the interest costs on the loan.
b. What is her dollar profit based on the bond’s current price? (Do not round intermediate calculations and round your answer to 2 decimal places.)
c. How much of the purchase price of $1,070 did Ms. Bright pay in cash? (Do not round intermediate calculations and round your answer to 2 decimal places.)
d. What is Ms. Bright’s percentage return on her cash investment? Divide the answer to part b by the answer to part c. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Interest rates and bond prices (face value is $1,000 and annual coupon rate is 12%) Table 16-2 Rate in the Market (%)--Annual Yield to Maturity" 10% 12% 14% 16% 8% $1,037.72 $1,018.59 $1,000.00 $981.92 $964.33 $1,345.84 $1,153.72 $1,000.00 $875.91 $774.84 $1,429.64 $1,182.56 $1,000.00 $861.99$755.33 2 Years to Maturity 4 15 +PV(F2/2,A5*2,-120/2,-1000) +PV(rate,nper,pmt,[fv]) Prices are based on semiannual payments. Thus, the annual rate is divided by two and the periods are multiplied by 2. Cash flow inputs are entered as negative values as required by Excel's PV function.Explanation / Answer
a) Bond currently has 15 years left to maturity and current YTM is 8%. So, current price @8% and 15 years to maturity is $1,345.84.
b) Dollar profit = Current price - Purchase price = $1,345.84 - $1,070 = $275.84
c) She paid 40% in cash.
Cash investment = $1070 x 40% = $428.00
d) Percentage return = (Dollar profit / cash investment) x 100 = ($275.84 / $428) x 100 = 64.448598% or 64.45%
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