Atlantic Airlines Atlantic Airlines issued $100 million in bonds in 2015. Because of the firms low credit rating (B3), the bonds were considered to be junk bonds. At the time of issue, the 20 year bonds were paying a yield of 12 percent. Tom currently held Treasury bonds paying four percent interest and corporate bonds yielding six percent. He wondered why the debt issue of Atlantic Airlines was paying twice that of his other corporate bonds and eight percent more than Treasury securities.

Required

1.If the yield in the market for bonds of this nature were to go up to 15 percent due to poor economic conditions, what would the new price of the bonds be? They have an initial par value of $1,000. Assume two years have passed and there are 18 years remaining on the life of the bonds. Use annual analysis.

2.Compare the decline in value to the eight percent initial interest advantage over Treasury bonds (12 percent versus four percent) for this two year holding period. Base your analysis on a $1,000 bond. Disregarding tax considerations, would Tom come out ahead or behind in buying the high yield bonds?

3.Recompute the price of the bonds if interest rates went up by only one percent to 13 percent with 18 years remaining. Does the 8 percent interest rate advantage over the two year holding period cover the loss in value?