Fifteen years ago McDemott's Motels Inc.issued twenty-five-year 10% annual coupon bonds with a $1,000 face value each.Since then,interest rates in general have fallen and the yield to maturity on the firm's bonds is now 6%.Given this information,what is the price today for such a bond?

Question

Quizplus · Accepted Answer

The price of a bond is calculated using the present value of its future cash flows, which include the annual coupon payments and the face value at maturity. Given the bond's annual coupon rate is 10% of the $1,000 face value, it pays $100 in coupons each year. With 10 years remaining (25-year bond issued 15 years ago) and a current yield to maturity of 6%, the price of the bond is calculated using the formula for the present value of an annuity (for the coupon payments) plus the present value of a lump sum (for the face value repayment at maturity). The bond's price exceeds its face value because the coupon rate is higher than the current yield to maturity, indicating the bond is trading at a premium. The correct calculation results in a price of $1,294.40.

Fifteen Years Ago McDemott's Motels Inc