a. Several years ago, Castles in the Sand Inc. issued bonds at face value o$1,00

Question

a. Several years ago, Castles in the Sand Inc. issued bonds at face value o$1,000 at a yield to maturity of 8.8%. Now, with 7 years left until the maturity of the bonds, the company has run into hard times and the yield to maturity on the bonds has increased to 14%. What is the price of the bond now? (Assume semiannual coupon payments.) (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Bond price___________

b. Suppose that investors believe that Castles can make good on the promised coupon payments but that the company will go bankruot when the bond matures and the principal comes due. The expectation is that investors will receive only 86% of face value at maturity. if they buy the bond today, what yield to maturity do they expect to receive? ( Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Yield to maturity __________________%

Explanation / Answer

a. Bond price is $ 776.97

Present value of the bond = Annual coupon payments x PVIFA 14%, 7 years + Maturity proceeds x PVIF14%, 7 years = 1,000 x 8.8% x 4.2883 + 1,000 x 0.3996 = $ ( 377.37 + 399.6) = $ 776.97

b. Yield to maturity: 19.42%

Yield to maturity can be computed by the following formula:

YTM = [I + ( F-V) /n] / ( 0.4 F + 0.6 V)

where, I = Annual coupon payments, F = Par value, V = Current price

n = Number of years to maturity

YTM = [ 88 + ( 1,000 -860)/ 7] / ( 1,000 x 0.4 + 860 x 0.6) = 108 / 916 x 100 = 11.79 %

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