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Bond Prices and Yield to Maturity

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18. Bond Prices and Yields.

a. Several years ago, Castles in the Sand, Inc., issued bonds at face value at a yield to maturity
of 7 percent. Now, with 8 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 15 percent. What has happened
to the price of the bond?

b. Suppose that investors believe that Castles can make good on the promised coupon payments,
but that the company will go bankrupt when the bond matures and the principal comes due. The expectation is that investors will receive only 80 percent of face value at maturity. If they buy the bond today, what yield to maturity do they expect to receive?

Solution Preview

a. Several years ago, Castles in the Sand, Inc., issued bonds at face value at a yield to maturity
of 7 percent. Now, with 8 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 15 percent. What has happened
to the price of the bond? ...

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