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Media Bias Inc. issued bonds 10 years ago at $1,000 per bond. These bonds had a 35-year life when issued and the annual interest payment was then 13 percent. This return was in line with the required returns by bondholders at that point in time as described below: Real rate of return 5 % Inflation premium 4 Risk premium 4 Total return 13 % Assume that 10 years later, due to good publicity, the risk premium is now 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 25 years remaining until maturity.

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jepessoa

Answer:

remaining time to maturity 25 years, annual coupon

face value $1,000

when the bonds were issued, the market interest rate was 13%, which was identical to the coupon rate, therefore, the bonds were sold at par

now, 10 years later, the market interest rate is 12% (1% less), so the current market price is:

PV of face value = $1,000 / (1 + 12%)²⁵ = $58.82

PV of coupon payments = $130 x 7.8431 (PV annuity factor, 25 periods, 12%) = $1,019.63

bond's current market price = $58.82 + $1,019.63 = $1,078.45

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