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 30-year life when issued and the annual interest payment was then 12 percent. This return was in line with the required returns by bondholders at that point in time as described below: Real rate of return 4 % Inflation premium 4 Risk premium 4 Total return 12 % Assume that 10 years later, due to bad publicity, the risk premium is now 6 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.

Explanation / Answer

The new price of the bond = $867.54

Using financial calculator BA II Plus - Input details:

#

I/Y = R = Real rate + inflation premium + Risk premium = 4%+4%+6% =

            14.000000

PMT = Payment =

-$120.00

N = Total number of periods = Number of years =

20

FV = Future Value =

-$1,000.00

CPT > PV = Present Value of the instrument =

$867.54

Formula for bond value = |PMT| x ((1-((1+R%)^-N)) / R%) + (|FV|/(1+R%)^N)

Using financial calculator BA II Plus - Input details:

#

I/Y = R = Real rate + inflation premium + Risk premium = 4%+4%+6% =

            14.000000

PMT = Payment =

-$120.00

N = Total number of periods = Number of years =

20

FV = Future Value =

-$1,000.00

CPT > PV = Present Value of the instrument =

$867.54

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