Wilson Oil Company issued bonds five years ago at $1,000 per bond. These bonds h

Question

Wilson Oil Company 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 15 percent. This return was in line with the required returns by bondholders at that point in time as described next:

Real rate of return ...........................     8%

Inflation premium ...........................     3

Risk premium ...............................      4

Total return ...................................   15%

Assume that 10 years later, due to bad publicity, the risk premium is now 7 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 15 years remaining until maturity. Compute the new price of the bond.

This is what I came up with - but feel it is wrong.

Real Rate of Return 8%

Inflation Premium 3%

Risk Premium 7%

8% Total Required Return

N=15, I/Y = 18, PV =CPT PV -847.25, PMT = 150, FV 1,000

Bond Price = $847.25

Present Value of Interest Payments

PVA = A X PVIFA (n=15, i=18%)

PVA = $150 x 5.092 = $763.80

Present Value of Principal Payment Maturity

PV=FVxPVIF (n=15,i=18%)

PV = $1,000 x .084 = $84.00

$763.80 + $84.00 = $847.80

Bond Price = $847.80

Explanation / Answer

Particulars

#

F = Face value =

$1,000.00

C = Coupon rate =

15.00%

R = Yield = YTM =

18.00%

N = Number of coupon payments till maturity =

15

Formula for bond value = (C x F x ((1-((1+R)^-N)) / R) + (F/(1+R)^N)

Bond Value = ((15%)*1000*((1-((1+(18%))^-15))/(18%))+(1000/(1+(18%))^15)) =

$847.25

----

I am getting $847.25 vs Your answer of $847.80 a small difference of 0.55 cents.

Particulars

#

F = Face value =

$1,000.00

C = Coupon rate =

15.00%

R = Yield = YTM =

18.00%

N = Number of coupon payments till maturity =

15

Formula for bond value = (C x F x ((1-((1+R)^-N)) / R) + (F/(1+R)^N)

Bond Value = ((15%)*1000*((1-((1+(18%))^-15))/(18%))+(1000/(1+(18%))^15)) =

$847.25

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